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ECON Market Failure

The document discusses market failure, highlighting how free markets can lead to inefficient resource allocation and deadweight loss. It categorizes externalities into negative and positive production and consumption, explaining their impacts on society and the need for government intervention. Additionally, it defines merit and demerit goods, public goods, and the free rider problem, emphasizing the role of imperfect information in consumer and producer decisions.

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yimclementcly0102
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5 views

ECON Market Failure

The document discusses market failure, highlighting how free markets can lead to inefficient resource allocation and deadweight loss. It categorizes externalities into negative and positive production and consumption, explaining their impacts on society and the need for government intervention. Additionally, it defines merit and demerit goods, public goods, and the free rider problem, emphasizing the role of imperfect information in consumer and producer decisions.

Uploaded by

yimclementcly0102
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Market failure – when the outcome of a free market differs from the

socially optimal outcome (when price mechanism leads to an inefficient


allocation of resources and a deadweight loss of economic welfare);
results in allocative inefficiency (underallocation/overallocation); when the
market fails to consider society as a whole

Negative Production Externalities

- Occurs when a production activity imposes costs to anyone not in


control of the decision-making process
- Producers do not bear the whole cost of the production and there
are spillover costs
- Social costs (external costs + private costs) > private cost (cost to
decision-maker)
- Private costs of producing the good are too low from society’s
standpoint, the good is overproduced
- Society demands less than what is produced
- Government intervention – impose bans/taxes to increase private
costs (internalize external effect)
- E.g. industrial pollution (affects the surrounding environment),
nuclear power generation (radiation leaks), transport of goods
(traffic congestion)

Positive Production Externalities

- E.g. honey (pollination)

Negative Consumption Externalities

- Occurs when a consumption activity imposes costs to a third-party


- Consumers bring costs to others without realising
- Leads to spillover costs
- Private costs of consuming the good are too low, the good is
overconsumed
- Society demands less than what is consumed
- E.g. alcohol (drinker may bring about social disturbance and public
safety), driving (traffic congestions), smoking (passive smoking)

Positive Consumption Externalities

- Occurs when a production activity imposes benefit to a third-party


- Social benefits (external benefits + private benefits) > private
benefits (benefits received by decision-maker)
- Private benefits of consuming the good are low for the consumer
compared to the social benefits, consumers demand less, producers
produce less (free market), the good is underproduced
- Society demands more than what is produced
- E.g. vaccination, education
- Government intervention – provide tax exemptions/subsidies to
increase private benefits

Merit Goods

- Goods that are more beneficial to consumers than they realise


(normative, decided by politicians)
- Imperfect information
o Information failure – incomplete/lack of information/ignored
information
o Asymmetric information – information is not shared equally
between two parties
- Positive externality
- Producers/consumers do not realize the benefit brought to society
by producing/consuming the good
- Producers and consumers make irrational decisions due to lack of
information
- Producers produce less/consumers demand less, the good is
underproduced and underconsumed

Demerit Goods

- Goods that are more harmful to consumers than they realise


- Imperfect information
- Negative externality
- Producers/consumers do not realize the harm brought to society by
producing/consuming the good
- Producers produce more/consumers consume more, the good is
overproduced and overconsumed

Public Goods

- Non-exclusion goods
o People who don’t pay cannot be excluded from enjoying the
good, e.g. streetlights, national defence
o Difficult to charge a price (no efficient way/expensive to price)
- Non-rivalry goods (shared consumption)
o People who enjoy the good will not ruin the good for other
people
o The quantity of the good does not diminish upon consumption
- Quasi-public goods
o Goods that show characteristics of both public and private
goods, e.g. roads (toll roads are excludable, congested roads
during peak times are rival)
- Free rider problem – individuals are incentivised to not contribute
and benefit from others’ contributions
- Firms do not produce public goods since there is no profit (no
consumers are willing to pay) – complete market failure (missing
market)
- Solutions
o Governments provide public goods using tax revenues
o Agreeing to private provision of public goods, e.g. hotel-owned
beaches accessible only to hotel guests
o Develop technology for more efficient/cost-effective ways of
pricing, e.g. electronic scanners for toll roads

*Note: Specify the market when drawing a diagram

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