Revision presentation - market failure.pdf
Transcript of Revision presentation - market failure.pdf
Externalities, solutions and other market failure
Today’s presentation
What is market failure?
Externalities
Solutions
Other kinds of market failure
What is market failure?
This definition comes up regularly!
It pays to define this term whenever it appears in the question (just like other definitions)
Externalities
Things you need to know
What they are
Positive and
negative
The diagrams
What makes them
large/small
Solutions
What are externalities?
Positive externalities
Negative externalities
The costs or benefit
received by a third party
to an economic
transaction outside of the
market mechanism; i.e.
the spillover effects of an
economic activity.
What things go in externality diagrams?
MSC, MPC, MSB, MPB
Private = Social optimum
DWL Under/overproduction
Externality 1: a negative externalityPri
ce
Quantity
1. MSC, MPC, MSB, MPB
2. Private =
3. Social optimum
4. DWL
5. Under/overproduction
MPC
MSC
MPB = MSB
Q2
P2
Social optimum
Q1
P1 Private equilibrium
Deadweight welfare loss
Overproduction
Externality 1: a positive externalityPri
ce
Quantity
1. MSC, MPC, MSB, MPB
2. Private =
3. Social optimum
4. DWL
5. Under/overproduction
MPC
MSB
MPB
= MSC
Q2
P2 Social optimum
Q1
P1Private equilibrium
Deadweight welfare loss
Under-
production
How big is the externality?
Ways to think about size of
externality eval
Short run vslong run
Long run impact may be greater
since…
Ceteris paribus…?
Government intervention? New tech?
Magnitude of impact – link to
data
UK is very reliant on GM
since…
Do some external benefits outweigh costs?
External benefits in improved health…
Category Types
Are solutions good/ bad?
Cost/ revenue to government?
Government failure?
Effectiveness and enforcement?
Impact on firms and UK economy
Fairness?
Solution 1: taxationExplanation
•A pigouvian tax is set to shift the MPC
curve towards the MSC curve
•In theory the level of the tax per unit
should be exactly equal to the marginal
external cost
•This internalises the externality
Diagram
Example
Pri
ce
Quantity
MPC
MSC
MPB =
MSB
Q2
P2
Social
optimum
Q1
P1 Private equilibrium
Original
DWL
Over-
production
MPC TAX
Q3
P3
Reduced
DWLUnit
tax
Are solutions good/ bad?
Cost/ revenue to government?
Governments make revenue
from taxes
Government failure?Information
problem
Effectiveness and enforcement?
Risk of smuggling and black markets
Impact on firms and UK economy
International competitiveness
Fairness? Producer pays!
Solution 2: extending property rightsExplanation
•Through the extension of property rights
companies and consumers are able to seek
compensation from companies and individuals
which pollute.
•This raises costs for firms
•This is a means by which the problem of the
externality is internalised, and so eliminating
the problem by bringing it back into the market
mechanism.
Diagram
Example
•Extended property ownership over
bodies of water, or even the air above
your house
Pri
ce
Quantity
MPC
MSC
MPB =
MSB
Q2
P2
Social
optimum
Q1
P1 Private equilibrium
Original
DWL
Over-
production
MPC 2
Q3
P3
Reduced
DWLUnit
tax
Are solutions good/ bad?
Cost/ revenue to government? Very low (ignoring court costs)
Government failure?Lack of financial support for the
scheme?
Effectiveness and enforcement?
1) Information problem
2) Other countries?
Impact on firms and UK economy
International competitiveness
Fairness?
1) Costs to seek claim. Favours the rich
2) BUT those harmed get the compensation.
Solution 3: regulationExplanation
•Minimum standards can be put
in place that force firms to only
pollute below a certain amount
•This solution is very simply – it
simple caps the amount of
pollution the firm can produce
Example
Examples include:
1. Setting minimum standards for
health and safety at the workplace
2. Penalties for firms who pollute too
much
3. Banning cigarette advertising and
making workplaces no-smoking
environments
Are solutions good/ bad?
Cost/ revenue to government?High supervision and
enforcement costs
Government failure?
1) Information problem
2) Risk of regulatory capture and weak regulators
Effectiveness and enforcement?
Possibility of evading regulation
Impact on firms and UK economy
Impact of ‘red tape’ and bureaucracy on costs
Inefficient distribution
Fairness?Does not necessarily raise costs for polluter or compensate consumer
Solution 4: tradable permitsExplanation
•The regulation solution was
inefficient as it did not distribute
the costs of reducing
emissions well
•Tradable permits try and do this
•A firm that finds it difficult to cut
down emissions can buy from a
firm that finds it much easier.
That way the reduction in
pollution is done at minimum cost
Tonnes
of
Carbon
Firm A cost to
remove
Firm B cost to
remove
1 £12,500 £17,000
2 £12,000 £16,000
3 £11,500 £15,000
4 £11,000 £14,000
5 £10,500 £13,000
6 £10,000 £12,000
7 £9,500 £11,050
8 £9,000 £10,000
9 £8,500 £9,000
10 £8,000 £8,000
Are solutions good/ bad?
Cost/ revenue to government?
High supervision and enforcement costs
Government failure? Number of permits
Effectiveness and enforcement?
Possibility of evading regulation
Impact on firms and UK economy
Possibility of monopoly power
Fairness?How to fairly distribute permits? Given away?
Explanation•A pigouvian tax is set to shift the MPC
curve towards the MSC curve
•In theory the level of the tax per unit
should be exactly equal to the marginal
external cost
•This internalises the externality
Diagram
Example
Pri
ce
Quantity
MPC=MSC
MSB
MPB
Q2
P2 SO
Q1
P1
PE
Original DWL
Under-
production
Solving positive externalities 1: subsidies
MPC 2
Q3
P3
Reduced
DWLUnit
subsidy
Are solutions good/ bad?
Cost/ revenue to government?
High cost
Government failure?
Political self-interest –too large?
Effectiveness and enforcement?
Is the subsidy well targeted and used?
Impact on firms and UK economy
Create inefficiency?
Fairness?Consumers benefit from lower prices
Solving positive externalities 2 – direct
provisionExplanation
•In some cases governments
chose to directly provide the
goods themselves
•This is more often used in
cases such as public goods, but
can also be used for
externalities (especially positive
ones)
Example
Examples include:
1. Provision of healthcare
2. Provision of education
3. In the case of public
goods, street lighting and
national defence
Are solutions good/ bad?
Cost/ revenue to government?
High cost – will often require increased taxes
Government failure?Problems of self-interest and
myopia
Effectiveness and enforcement?
Lack of efficiency in the public sector
Potential over-consumption
Impact on firms and UK economy
Reduce size of private sector - potential SS impact
Fairness? Equitable distribution
Other market failure
Unstable prices
Causes
Inelastic supply
Inelastic
demand
Regular and
unpredictable
supply/demand
shocks
Pri
ce
Quantity
D
SS1
Q2
P2
Q1
P1
BIG
Change
In
Price
Problems
Problems for
Firms
Sudden loss of revenue and profit
Inefficiency – hard to know what to grow
Unpredictability leading to under-investment
Good firms can go bankrupt
Consumers
Lack of security
Inability to plan effectively
Potential impact on inflation
Buffer stock schemes
Q3
In good years…Pri
ce
Quantity
D
S
Ptarget
P1
Q1Q2
Spending on scheme
Q3
In bad years…Pri
ce
Quantity
D
S
Ptarget
P1
Q1Q2
Profit from scheme
Will they work?
Will it work?
Is the scheme open to
government failure?
Is successful cooperation
likely?
Can the good be stored?
Can the costs of storage be
paid?
Is there enough
finance for the scheme?
Public goods
Evaluating public goods
Parks
Non-rival?
Non-excludable?
TV signals
Non-rival?
Non-excludable?
Music downloads
Non-rival?
Non-excludable?
Other areas to look at