Market Failures Exploring Remedies for Externalities

Transcription

1 U4;N3 Market Failures Exploring Remedies for Externalities A market failure is the inability of the market to produce a desirable product or to produce a desirable product in the "right" amount. Market failures are a common occurrence, as positive and negative externalities yield results that are imperfect (or, at least, not ideal) and warrant correction. We will consider several methods for correcting allocative issues in the market and reducing the incidence of market failures. Overallocation Overallocation is a consequence of negative externalities. There are two scenarios that yield this result, described below. (1) Negative production reduces the well being of others. Thus, the marginal social cost is greater than the marginal private cost and the market equilibrium is greater than the optimal equilibrium; the market must shift to correct this. s > p > (2) Negative consumption reduces the well being of others. Thus, the marginal private benefit is greater than the marginal social benefit and the market equilibrium is greater than the optimal equilibrium; the market must shift to correct this. > > Underallocation Underallocation is a consequence of positive externalities. There are two scenarios that yield this result, described below. (1) Positive production increases the well being of others. Thus, the marginal private cost is greater than the marginal social cost and the optimal equilibrium is greater than the market equilibrium; the market must shift to correct this. p > s > (2) Positive consumption increases the well being of others. Thus, the marginal social benefit is greater than the marginal private benefit and the optimal equilibrium is greater than the market equilibrium; the market must shift to correct this. > >

2 Now that we know all of the ways in which the market can yield allocative inefficiency, we will evaluate the methods commonly used to correct these failures. Direct Controls Taxes Subsidies To Buyers Subsidies To Producers Government Provision Legislative policy that limits certain actions and/or forces offending parties to pay the external costs for their actions. Charges levied on the specific good or service in question. Tax reductions, cash payments, and/or discount coupons granted to consumers for the purchase of a particular good. Tax reductions or cash payments to producers in order to help defray their production costs. Goods and services that are widely needed provided for consumers for free or an otherwise nominal charge. For negative externalities, you must shift LEFT to reduce output to optimal level. s p Overallocation For positive externalities, you must shift RIGHT to increase output to optimal level. p s Underallocation

3 Market Failures & Remedies Practice For each of the scenarios below, complete the following: (1) identify whether the issue at hand yields a positive or negative externality; (2) identify whether the issue is on the production or consumption side of the market; (3) illustrate the resulting marginal analysis on the graph and be sure to include all necessary labels; (4) identify and explain the remedial measure prescribed for this market failure. Issue: Cars, industries, homes, and major appliances are leading causes of high greenhouse gas emissions. Remedy: The Department of Energy and the Environmental Protection Agency (EPA) establish the Energy Star program to denote compliance with strict energy standards. Issue: The use of heavy vehicles (i.e. SUV's average around 4,500 pounds) is a major cause of wear and tear on area roadways. Remedy: The PA Department of Transportation (PENNDOT) sends crews to survey and repair the damaged highways and freeways. Issue: Hydraulic fracturing or "fracking" is employed to unearth natural gas and other energy alternatives to oil, potentially affecting the surrounding environment. Remedy: Governor Wolf proposes a 5% extraction tax on the drilling and gas companies.

4 Issue: Electric cars, which reduce harmful pollutants, are selling sluggishly. Remedy: The federal government offers a $1, tax credit to all consumers who purchase an electric car during the fiscal year. Issue: An industrial contracting company offers first aid and safety training classes to all employees. Remedy: The federal government provides a "Safety First" grant to the company, covering all outside training and personnel education costs for the year. Any Other Examples? Are there any instances in your life (or in the world, more broadly) that you can think of as yielding a positive/negative externality and warranting a remedy?

5 Market Failures & Remedies Key For each of the scenarios below, complete the following: (1) identify whether the issue at hand yields a positive or negative externality; (2) identify whether the issue is on the production or consumption side of the market; (3) illustrate the resulting marginal analysis on the graph and be sure to include all necessary labels; (4) identify and explain the remedial measure prescribed for this market failure. MB s MB s MB s p Issue: Cars, industries, homes, and major appliances are leading causes of high greenhouse gas emissions. Remedy: The Department of Energy and the Environmental Protection Agency (EPA) establish the Energy Star program to denote compliance with strict energy standards. (1) Direct Control/(2) Government Provision: (1)The EPA guidelines and standards must be followed, otherwise companies are subject to fines and unfavorable evaluations. (2) The government provides these standards due to national need. Issue: The use of heavy vehicles (i.e. SUV's average around 4,500 pounds) is a major cause of wear and tear on area roadways. Remedy: The PA Department of Transportation (PENNDOT) sends crews to survey and repair the damaged highways and freeways. Government Provision: (1)The government provides means and resources for road work because it is a widespread need. Issue: Hydraulic fracturing or "fracking" is employed to unearth natural gas and other energy alternatives to oil, potentially affecting the surrounding environment. Remedy: Governor Wolf proposes a 5% extraction tax on the drilling and gas companies. Taxes: (1) The government makes up for the negative production externality with a tax, discouraging the practice of fracking and reducing output.

6 Issue: Electric cars, which reduce harmful pollutants, are selling sluggishly. Remedy: The federal government offers a $1, tax credit to all consumers who purchase an electric car during the fiscal year. Subsidy to Buyer: (1) The government encourages higher consumption and greater output by subsidizing purchases of environmentally friendly cars. Issue: An industrial contracting company offers first aid and safety training classes to all employees. Remedy: The federal government provides a "Safety First" grant to the company, covering all outside training and personnel education costs for the year. p s Qo MB Subsidy to Producer: (1) The government encourages higher output of safety initiatives by incentivizing the practice through federal subsidies. Any Other Examples? Are there any instances in your life (or in the world, more broadly) that you can think of as yielding a positive/negative externality and warranting a remedy?