Market Failure. Non-provision of public goods (complete market failure) Presence of externalities (partial market failure)

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1 Non-provision of public goods (complete market failure) Market Failure Presence of externalities (partial market failure) Information Failure (partial market failure) Merit & Demerit goods (partial market failure)

2 SCARCITY CHOICE OPPORTUNITY COST What & how much to produce How to produce For whom to produce Price Mechanism (Free market economy) 9.5

3 Resource Allocation & Price Mechanism Recall: What and how much to produce? Price movements act as signals to producers to produce goods and services desired by consumers How to produce? Use the most efficient methods to minimize costs (productive efficient) For whom to produce? Prices serve to ration the goods to those who can afford to paythe highestpossibleprice 9.5

4 Resource Allocation & Price Mechanism Recall: The price mechanism allocates scarce resources according to the preferences of consumers and produces the correct quantities in the most efficient way. Hence, allocative efficiency is achieved and society s welfare is maximized. 9.5

5 What is Market Failure? Market failure occurs when free markets, operating without any government intervention, fail to allocate scarce resources efficiently and hence society s welfare is not maximised. E.g. no / insufficient / excess resources allocated to production of goods à allocative inefficient output à welfare not maximised. 9.6

6 Government intervenes when there are Market Failure Inequity Non-provision of public goods (complete market failure) Presence of externalities (partial market failure) Information Failure (partial market failure) Merit & Demerit goods (partial market failure)

7 Causes of Market Failure 1. Non-provision of Public Goods 2. Externalities Negative Positive 3. Information failure 4. Merit & Demerit goods 9.6

8 Inequity Another goal of government is to ensure fairness in the distribution of economic welfare, i.e. equity Left to the market, inequality results at times. Hence government needs to step in. 9.7

9 9.3.1 PUBLIC GOODS 9.7

10 Will you ever pay for Street lightings? National defence? 9.7

11 Public Goods: The Problem Goods & Services that will NOT be provided by the market They are non-excludable and non-rivalry in consumption. 9.7

12 Non-excludable Impossible/ prohibitively expensive to exclude non-payers from consuming it Implication: Free-rider problem à No effective demand No price signals à No firm will supply à Zero resources allocated Non-rivalry Consumption by one does not reduce the amount available to others Implication: MC of providing the good to an additional consumer is 0 à Allocative efficiency: P =MC (=0) à No firms will supply if P=0 The market will not provide such a good à complete market failure 9.7

13 Identify the key differences between Public goods & private goods Pure public goods are characterized by: non-excludable in consumption non-rivalry in consumption Private goods are characterized by: Excludable in consumption Rivalry in consumption 9.8

14 Distinguishing Criteria Rivalrous in consumption - Definition: The consumption of the good by one person diminishes the amount available for another person to consume. Private goods Yes Explain the concept of rivalry using an example of one person s consumption of good/service such as car, running shoes, hair dressing - When one person enjoy the good, there will be one less available for the others. Public goods No Explain the concept of non-rivalry using an example of street lighting - The consumption of street lighting by one person does not diminish the quantity or quality available for the next person. Excludable in consumption - Definition: Means that it is technically possible or feasible to exclude anyone who has not paid for the good/service from consuming it once it is produced. Yes Explain the concept of excludability using an example of use of smartphones, computers, big macs - The direct benefits from the consumption of the good is confined to those who pay for it. No Explain the concept of non-excludability using an example of street lighting No single person has to pay to enjoy the light provided by street lighting. i.e. it is technically impossible / prohibitively expensive to exclude anyone who walks on the street from benefiting from it even though he /she doesn t pay for it directly.

15 Are the following examples public goods and why? (i) Free-to-air TV broadcast (ii) Roads

16 (i)free-to-air TV broadcast TV broadcast signals are non-rival since quality of signal is not degraded for additional viewers or the number and quality of the shows on air is independent of the number of viewers. Free to air TV broadcast signals were not excludable as it is an obligation that they have to fulfill as part of their broadcasting license. Thus it is impossible for them to encrypt the signals as part of national duty even if they want to and that there is a very high penalty (their license will be revoked) i.e. cost involved if they should exclude non-payers. OR : The broadcast signal is not encrypted and thus anyone with a television will be able to watch the shows that has been broadcasted, payer or non-payer. àcan be considered as Public Good

17 (ii) roads Roads essentially public in nature, but do not exhibit fully the features of non-excludability and non-rivalry. The road network is currently available to all, but could be made excludable via a system of electronic road pricing/ toll charges. There is also non-rivalry in consumption, but only up to an extent. Once the road becomes congested there is rivalry in consumption. Hence it is not a pure public good Additional knowledge: Can be considered as quasi public good.

18 Public Good - Solutions Police protection Direct Provision by Govt 9.8

19 Public Good - Solutions The Government Unlike the private sector, objective is NOT to maximize profits Max Social Welfare Take into account full social costs & benefits generated by public goods. How to produce? Direct provision by govt. Outsource to private sector but paid for via tax revenue 9.8

20 Limitations: Lack of Information How much to produce? Public goods What is the optimal level to produce? Without price signals, it is not easy for govt to decide 9.9

21 Limitations: Lack of Funds Funded from tax revenues Public Goods Recession: Not enough tax revenues Spending constrained 9.9

22 Limitations: Political Pressures Self Interest: Political popularity Public goods Misallocation of resources E.g. cut taxes for the rich (but result in less funding for national defense) 9.9

23 End of Lesson Reflection