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Chapter 12 IB Economics: Market Failure

A review of market failure for IB Economics students

Daniel Broadley

on 19 October 2016

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Transcript of Chapter 12 IB Economics: Market Failure

The Economics
Market Failure
Types of Market Failure
3. Under-supply of Merit Goods
2. Over- supply of De-Merit Goods
1. Lack of Public Goods
6. Monopolies (Imperfect Competition - HL)
4. Factor Immobility
5. Imperfect Information - HL
Public Goods are
"Non excludable"
Public Goods are
"Non rival"
Drawing the Diagrams
You are a spinning top
In the morning you feel negative
In the evening you feel positive
Getting the labels right:
1) B's fly down to land...PMB and SMB slope downwards
2) High C's...PMC and SMC slope upwards
3) We want SMC = SMB...it must lead to p2 and q2
Correcting Market Failure
1. Fiscal Policy
Information Campaign
What is Market Failure?
Market failure occurs when the market fails to provide full efficiency. i.e. a community surplus.
Allocative efficiency occurs when MSC = MSB

Private cost + Negative Externality = Social Cost

Private benefit + Positive Externality = Social Benefit
Consumption cannot be prevented
Consumption by one doesn't
diminish what's left for others
Outright ban
Partial ban
Age Related
a. Subsidising Merit Goods
b. Taxing Demerit Goods
Government Provision of
Public Goods

So the top tips to the left
So the top tips to the right
These are goods the production or consumption of which creates negative externalities.
These are goods the production or consumption of whcih creates positive externalities.
So pubic goods are not provided at all in the free market, due to the "free rider problem", so the market fails
Externalities are ignored by the free market when setting price, so demerit goods are under priced and over consumed - so the market fails.
Externalities are ignored by the free market when setting price, so merit goods are under valued and under consumed - so the market fails.
Name the demerit good.

Explain the negative externality.

Identify who pays for it.

Name the merit good.

Explain the positive externality.

Identify whom it benefits.

Factor immobily is when a factor of production cannot be switched costlessly between applications.
Nurses in Newcastle cannot afford to nurse in London
There are geographical barriers.
This means that the distribution of nurses is inefficient
Information asymmetry is when one economic agent knows more or less than another.
It leads to inefficient decision making (over or under consumption).

For example, the lady in the photo is using looks as a "proxy measure" of value. In reality, that man has £450,000 of debt and smelly feet.

Think "houses", "red meat" and such like.
Monopoly firms may have a degree of market power.

They may set price higher than marginal cost and may restrict output / choice, all of which are potentially inefficient.
Could generate SMB = SMC
Generates revenue

Burden of tax falls most heavily on the poor
Might under or over correct market failure

Effectiveness depends on PED
Effectivenes depends on collection costs
Policing costs may be an issue
Might lead to secondary market

Can be very fast to implement
Can be quite easy to understand

Effect depends on whether it can be implemented
Effect depends on policing costs
May lead to government failure
May bring unintended consequences
May correct market failure
May price low income groups into the market
Subsidies can be targeted
Opportunity cost may be high
Externalities hard to measure
How to fund it?
Depends on cost of administration
May be difficult to target right people
Depends on how funded
Essential to deal with free rider problem
May correct market failure
Externalities may be spurious
Not all people may benefit
Depends on efficiency of provision
New technology may strongly affect market
When markets fail, governments generally need to intervene.
Insert Diagram Fig 12.1
Public Goods would not provided in a free market
Describe a picture of what Örebro would look like without government intervention! What would it look like? what would there be more or less of?
It is impossible to stop other people from consuming the good even when others have paid for it
Perfect information / knowledge assumption
Full transcript