Edexcel (A) Economics A-level

Transcription

1 Edexcel (A) Ecnmics A-level Theme 1: Intrductin t Markets and Market Failure 1.3 Market Failure Externalities Ntes

2 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. 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. Scial csts This is calculated by private csts plus external csts

3 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. 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. Scial ptimum psitin: 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:

4 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: 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. Gvernment plicies fr negative externalities:

5 Indirect taxes: t reduce the quantity f demerit gds cnsumed. This increases the price f the gd. If the tax is equal t the external cst f each unit, then the supply curve becmes MSC rather than MPC, s the free market equilibrium becmes the scially ptimum equilibrium. This internalises the externality. In ther wrds, the plluter pays fr the damage. Subsidies: encurage the cnsumptin f merit gds. This includes the full scial benefit in the market price f the gd. Regulatin: t enfrce less cnsumptin f a gd. Fr example, the minimum schl leaving age. If there was a cmpulsry recycling scheme, it wuld be difficult t plice and there culd be high administrative csts. Bans culd be enfrced fr harmful gds, althugh they can still be cnsumed n the black market. Bans are nly useful where MSC > MPB (the MSC curve is abve MPB). Prvide the gd directly: The gvernment culd prvide public gds which are underprvided in the free market, such as with educatin. Prvide infrmatin: s there is n infrmatin failure, and cnsumers and firms can make infrmed ecnmic decisins. Prperty rights: this encurages innvatin because entrepreneurs can create new ideas, which are prtected, and earn prfit. Persnal carbn allwances: They culd be tradeable, s firms and cnsumers can pllute up t a certain amunt, and trade what they d nt use.