L5 Market Failure

8/3/2019 L5 Market Failure

1/44

Economic Welfare

p

qD = MPB = MSB

S = MPC = MSC

p*

q*

CS

PS


2/44

Maximization of Net Social

BenefitsNSB = s = PB(q) + EB(q) PC(q) EC(q)NSB = SB - SCFOC

s / q = PB/ q + EB/ q - PC/ q - EC/ q = 0PB/ q + EB/ q = PC/ q + EC/ qMPB + MEB = MPC + MEC

MSB = MSC


3/44

Net Social Benefits

p

qMPB

MSC

p*

q*

CS

PS

MPC

MSB


4/44


5/44

MSC > MPC

p

qMPB = MSB

MPC

p*

q*

MSC

qo

poCS

PS

Deadweight loss


6/44

MSB > MPB

p

qMPB

MPC = MSC

p*

q*

CS

PS MSB

qo

po


7/44

POSSIBLE CAUSES OF

MARKET FAILURE

Thin Markets

A market is thin when there are not enoughtraders to allow it to operate or when it istoo costly to operate


8/44

Monopoly

p

qD

S

p*

q*

CS

PS

MR

pm

qm

Deadweight loss


9/44

Asymmetric Information

Lack of information about activitiesaffecting economic agents

Asymmetric information makes exchangethrough market mechanism quite difficult


10/44

Common property resources andnonappropriable externality

Nonapproriability means that any oneagent's consumption of the externality(pollution) does not reduce the consumptionof that same externality by others.


11/44

Negative Externalities

p

qMPB = MSB

MPC

p*

q*

MSC

qo

poCS

PS

Deadweight loss


12/44

Positive Externalities

p

qMPB

MPC = MSC

p*

q*

CS

PS MSB

qo

po


13/44

Nonconvexities in the operation of themarket or in the technological

interdependence

A nonconvexity in the market can be caused

by setup costs, e.g. bureaucracy. Anonconvexity in technology is when theproduction possibility fails to be

everywhere bowed out.


14/44

Price Support

p

qD

S

p*

q*qo

ps

q

CS

PS


15/44

Price Ceiling

p

qD

S

p*

q*

pc

qo q

PS

CS


16/44

Quantity Control

p

qD

S

p*

q*qo


17/44

The absence of Property Rights

property rights

The set of valid claims to a good or resourcethat permits use of that good or resourceand the transfer of its ownership throughsale


18/44

Coase Theorem

Proper assignment of property rights to anygood, even if externalities are present, willallow bargaining between affected parties

such that an efficient solution can beobtained, regardless of which party isassigned those rights


19/44

common property resources

Those resources for which property rightsare shared by some group of individuals


20/44

Environmental Quality: APublic Good

public good

A commodity that is nonrival inconsumption and yields benefits that arenonexcludable


21/44

nonrivalness

The characteristic of indivisible benefits of consumption such that one person'sconsumption of a good does not precludethat of another


22/44

nonexcludability

The characteristic that makes it impossible(or prohibitively costly in a less strict sense)to prevent others from sharing in thebenefits of a good's consumption


23/44

Individuals Demand P

Q

DADB


24/44

Market Demand P

Q

DADB

DM


25/44

Market Equilibrium? P

Q

DADB

DM

S

Q*


26/44

Concept of external economies(diseconomies)

(Scitovsky, 1954)Readings\3. Environmental Externalities.pdf

Technological external economies

equilibrium theory: output decisions in oneindustry are co-determined by actions in otherindustries; these effects do not result from changesreflected in the product or factor prices.
http://readings/3.%20Environmental%20Externalities.pdfhttp://readings/3.%20Environmental%20Externalities.pdfhttp://readings/3.%20Environmental%20Externalities.pdfhttp://readings/3.%20Environmental%20Externalities.pdf


27/44

Pecuniary external economies

interdependence among producers through themarket mechanism, i.e. due to price effects.


28/44


29/44

The Theory of Externality

An externality is a spillover effect associated witheither production or consumption of a good or

service that extends outside the market to somethird party other than the producer or consumer of that good or service. If the external effectgenerates costs to a third party, it is a negative

externality . If the external effect generatesbenefits to a third party, it is a positiveexternality .


30/44

ENVIRONMENTAL

EXTERNALITIESReadings\3. Environmental Externalities.pdf Application of the concept of externalities to environmentalproblems

Externalities result from services (disservices) renderedfree (without compensation), and are a cause for divergencebetween private profit and social benefit

Externalities are a cause for the failure of perfectcompetition to lead to an optimum situation
http://readings/3.%20Environmental%20Externalities.pdfhttp://readings/3.%20Environmental%20Externalities.pdfhttp://readings/3.%20Environmental%20Externalities.pdfhttp://readings/3.%20Environmental%20Externalities.pdf


31/44

Environmental Externalities

Defined

non-market effects (+ve or -ve) which resultas a side-effect of economic activities of producers and consumers and which affectthe welfare or profit conditions of otherhouseholds through spill-overs via man'ssurroundings

Examples:


32/44

Examples:

negative

air pollution from automobiles; water pollution from factories dumping wastes; logging without afforestation; stenches from chemical plants;

positive

benefits derived from proximity of a natural park; benefits from the beauty of a well-designed building in the

vicinity;


33/44

Characteristics

Interdependency

No compensation

Unintended/incidental by-product [Mishan,1971]


34/44

Classification

1. (Non)-Separability

2. (Non)-Reciprocity

3. (Infra)-Marginality

4. Potential (Ir)-Relevance


35/44

Separability

C1 = C 1 (q1, q2) C2 = C 2 (q1, q2)

For individual firm's profit to be maximized,FOC:

pi = C i / qi

i = 1,2


36/44

For social benefit to be optimized,

FOC: pi = C i / qi + C j / qi

i = 1,2; j = 1,2;


37/44

Reciprocity

when 1 imposes an externality on 2 and viceversa

non-reciprocal (unidirectional): when 1imposes external effects on 2 but not vice

versa


38/44

Marginal Effects

[Buchanan and Stubblebine]

decision of 1 at the margin always affect thewelfare position of the others

infra-marginal: marginal change in thedecisions of a polluter leads to a marginal

change in environmental quality withoutaffecting the welfare position of othereconomic subjects


39/44

Potentially Relevant

when environmental spill-over generates desire onthe part of the damaged party to modify thebehaviour of the polluter through trade,persuasion, or collective actions

irrelevant, if externality exerts no such action

Infra-marginal externalities are, by definition,irrelevant.


40/44

Pollution as an Externality

Problem

C f = Q2;

B = 12Q or P = 12;

E = 0.01Q 2;

Cw = 20 + 50E;


41/44

NPB = = 12Q Q 2

MNPB = M = / Q = 12 2Q

At max NPB, MNPB = 0 or P = MC 12 2Q = 0; Q = 6

EC = 50E = 0.5Q 2

MEC = Q

At max NSB, MNPB = MEC 12 2Q = Q; 3Q = 12; Q = 4


42/44

Alternatively,

Max NSB = s = 12Q Q2

0.5Q2

= 12Q 1.5Q 2

FOCs / Q = 12 3Q = 0

Q = 4


43/44

MEC = Q

MNPB = 12 2Q

Q

MNPB, MEC

4 6

12

4

a

bc

d

e

a = 16b = 8

c = 8d = 4e = 6


44/44

The End

L5 Market Failure

Documents

Transcript of L5 Market Failure