WJEC (Eduqas) Economics A-level

Transcription

1 WJEC (Eduqas) Ecnmics A-level Micrecnmics Tpic 7: Market Failure 7.1 Understanding market failure Ntes

2 Market failure ccurs when the free market fails t allcate resurces t the best interests f sciety, s there is an inefficient allcatin f scarce resurces. Ecnmic and scial welfare is nt maximised where there is market failure. Efficiency ccurs when cnsumer and prducer surplus are maximised at the free market equilibrium utput. Types f market failure: Externalities An externality is the cst r benefit a third party receives frm an ecnmic transactin utside f the market mechanism. In ther wrds, it is the spillver effect f the prductin r cnsumptin f a gd r service. Externalities can be psitive (external benefits) r negative (external csts). Negative externalities are caused by demerit gds. These are assciated with infrmatin failure, since cnsumers are nt aware f the lng run implicatins f cnsuming the gd, and they are usually verprvided. Fr example, cigarettes and alchl are demerit gds. The negative externality t third parties f cnsuming cigarettes is secnd-hand smke r passive smking. Psitive externalities are caused by merit gds. These are assciated with infrmatin failure t, because cnsumers d nt realise the lng run benefits t cnsuming the gd. They are underprvided in a free market. Fr example, educatin and healthcare are merit gds. The psitive externality t third parties f educatin is a higher skilled wrkfrce. The extent t which the market fails invlves a value judgement, s it is hard t determine what the mnetary value f an externality is. Fr example, it is hard t decide what the cst f pllutin t sciety is. Different individuals will put a different value n it, depending n their wn experiences with pllutin, such as hw plluted their hme twn is. This makes determining gvernment plicies difficult, t.

3 Private csts Prducers are cncerned with private csts f prductin. Fr example, the rent, the cst f machinery and labur, insurance, transprt and paying fr raw materials are private csts. This determines hw much the prducer will supply. It culd refer t the market price which the cnsumer pays fr the gd. Marginal private cst is the cst t a firm f prducing ne extra unit. Scial csts This is calculated by private csts plus external csts On a diagram, external csts are shwn by the vertical distance between the tw curves. In ther wrds, external csts are the difference between private csts and scial csts. It can be seen that marginal scial csts (MSC) and marginal private csts (MPC) diverge frm each ther. External csts increase disprprtinately with increased utput. Marginal scial cst is the extra cst n sciety derived per extra unit cnsumed. Marginal scial cst = marginal external cst + marginal private cst Private benefit Cnsumers are cncerned with the private benefit derived frm the cnsumptin f a gd. The price the cnsumer is prepared t pay determines this. Private benefits culd als be a firm s revenue frm selling a gd. Scial benefit Scial benefits are private benefits plus external benefits. On a diagram, external benefits are the difference between private and scial benefits. Similarly t external csts, external benefits increase disprprtinately as utput increases. Marginal scial benefit is the extra benefit n sciety derived per extra unit cnsumed. Marginal scial benefit = marginal external benefit + marginal private benefit Scial ptimum psitin:

4 This is where MSC = MSB and it is the pint f maximum welfare. The scial csts made frm prducing the last unit f utput is equal t the scial benefit derived frm cnsuming the unit f utput. External csts f prductin: External csts ccur when a gd is being prduced r cnsumed, such as pllutin. They are shwn by the vertical distance between MSC and MPC. The market equilibrium, where supply = demand at a certain price, ignres these negative externalities. This leads t ver-prvisin and under-pricing. With negative externalities, MSC>MPC f supply. At the free market equilibrium, therefre, there are an excess f scial csts ver benefits at the utput between Q1 and Qe. The utput where scial csts > private benefits is knwn as the area f deadweight welfare lss, shwn by the triangle in the diagram. The market fails t accunt fr the negative externalities that ccur frm the cnsumptin f this gd, which wuld reduce welfare in sciety if it was left t the free market. External benefits f prductin:

5 An example f an external benefit frm the prductin r cnsumptin f a gd r service culd be the decline f diseases and the healthier lives f cnsumers thrugh vaccinatin prgrammes. Since cnsumers and prducers d nt accunt fr them, they are underprvided and under cnsumed in the free market, where MSB>MPB. This leads t market failure. The triangle in the diagram shws the excess f scial benefits ver csts. It is the area f welfare gain. The under-prvisin f public gds Public gds are nn-excludable and nn-rival, and they are underprvided in a free market because f the free-rider prblem. Public gds are missing frm the free market, but they ffer benefits t sciety. Fr example, street lights and fld cntrl systems are public gds. They are nn-excludable s by cnsuming the gd, smene else is nt prevented frm cnsuming the gd as well, and they are nn-rival, s the benefit ther peple get frm the gd des nt diminish if mre peple cnsume the gd. The nn-excludable nature f public gds gives rise t the free-rider prblem. Therefre, peple wh d nt pay fr the gd still receive benefits frm it, in the same way peple wh pay fr the gd d. This is why public gds are underprvided by the private sectr: they d nt make a prfit frm prviding the gd since cnsumers d nt see a reasn t pay fr the gd, if they still receive the benefit withut paying. Public gds are als underprvided because it is difficult t measure the value cnsumers get frm public gds, s it is hard t put a price n the gd. Cnsumers will undervalue the benefit, s they can pay less, whilst prducers will vervalue, s they can charge mre. Gvernments prvide public gds, and they have t estimate what the scial benefit f the public gd is when deciding what utput f the gd t prvide. They are funded using tax revenue, but the quantity prvided will be less than the scially ptimum quantity.

6 Private gds are rival and excludable. Fr example, a chclate bar can nly be cnsumed by ne cnsumer. Mrever, private prperty rights can be used t prevent thers frm cnsuming the gd. Infrmatin gaps It is assumed that cnsumers and prducers have perfect infrmatin when making ecnmic decisins. Hwever, this is rarely the case, and this imperfect infrmatin leads t a misallcatin f resurces. Mnplies Since the cnsumer has very little chice where t buy the gds and services ffered by a mnply, they are ften vercharged. This leads t the undercnsumptin f the gd r service, and therefre there is a misallcatin f resurces, since cnsumer needs and wants are nt fully met. Inequalities in the distributin f incme and wealth There is an unequitable distributin in incme and wealth. Incme refers t a flw f mney, whilst wealth refers t a stck f assets. This can lead t negative externalities, such as scial unrest. An absence f private prperty rights Cnsumers and prducers have a right f wnership f the gds they prduce where there are prperty rights. This encurages entrepreneurship and inventins, since ideas are prtected. Hwever, withut these rights, markets becme inefficient. Resurces culd be ver-explited r misused, which can lead t market failure. Vlatile prices Cmmdity prices are usually unstable, especially in the shrt run. The changes in supply affect the price f cmmdities, which is due t weather patterns and grwing cnditins. Fr example, fd prducers face unstable prices. This can mean incmes are fickle and unreliable, which can make it hard t make investments. It can lead t a misallcatin f resurces.