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MARKET FAILURE

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Todd Cota

on 20 March 2015

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Transcript of MARKET FAILURE

1)
Negative Externalities of Production (external costs)
2)
Positive Externalities of Production (external benefits)
3)
Negative Externalities of Consumption

4)
Positive Externalities of Consumption
4 TYPES OF EXTERNALITIES
ALLOCATIVE EFFICIENCY
Socially efficient, or in a state of allocative efficiency
Resources are allocated in the most efficient way, from society's point of view
TYPES OF MARKET FAILURE
TYPES OF MARKET FAILURE
2) UNDER SUPPLY OF MERIT GOODS/SERVICES
Under-provided in a free market
Under-consumed in a free market
All Merit Goods are Public Goods
education
health care
stadiums
TYPES OF MARKET FAILURE
TYPES OF MARKET FAILURE
1) LACK OF PUBLIC GOODS
goods that benefit society
not provided in a free mkt
national defense
flood barriers
Public Goods are:
a) Non-Excludable
Once provided, impossible to prevent others from consumption
Allows a free-rider problem
b) Non-Rivalrous
One persons consumption does not prevent others consumption
Government acts as provisionary of public good
paid for by govt tax revenue
e.g. - national defense
Subsidize private firms provision of good
public garbage bins
Tax Relief: decrease in taxes, so firm can allocate to R&D
Government Intervention to Reduce Market Failure
Fracking... Good and/or Bad?
Negative Externalities of Production
MARKET FAILURE: The Existence of Externalities
Pure Public Goods
Quasi public Goods
Market failure
occurs when free markets fail to deliver an optimal & efficient allocation of resources
, resulting in a loss of welfare. Market failure
exists when the competitive outcome of markets is not efficient from the point of view of society
as a whole. This is usually because the benefits that the free-market confers on individuals or businesses carrying out a particular activity differ from the benefits to society as a whole.

Government intervenes in support of merit goods
Direct provision
Subsidy (partial or full)
Merit Goods:
Goods/Services that benefit the people that use them & society as a whole. (e.g. MMR vaccination)
SPORTS STADIUMS AS A MERIT GOOD (! OR ?)
3) OVER-SUPPLY OF DEMERIT GOODS
Over-provided in a free market
Over-consumed in a free market
Demerit goods: Goods that are bad for the people that use them & society as a whole. (e.g. alcohol, cigarettes, hard drugs)
Government intervenes in attempts to control demerit goods
tax
illegal ban (may cause black markets
Examples of Demerit Goods:
alcohol
hard drugs
cigarettes
prostitution
EXISTENCE OF EXTERNALITIES
Externalities occur when production or consumption affects 3rd parties
Negative Externalities
private cost + external cost = full costs to society
Postitive Externalities
private benefit + external benefit = full benefits to society
MSC is equal to MPC (+/-) external cost or benefit of production
MPC = Private supply curve or Firm's private cost of production
If MSC=MPC = no externalities of production
----------------------------------------------------------------
MSB is equal to MPB (+/-) external cost or benefit of consumption
MPB = Private demand curve or Consumers benefits (utility)
If MSB=MPB = no externalities of consumption
MSC=MSB =
Social Efficiency
or maximum community surplus
MSC does not equal MSB =
Market Failure
/ inefficient allocation of societies resources
MSC=MSB
What are Externalities?
EXTERNALITY "REAL-WORLD" EXAMPLE
Directions:
Watch the "Externalities in Action" TED talk by Rob Harmon
Choose one of the Externalities that most correlates to this video.
Choose a graph that provides a diagrammatic proof of the story in the video.
Write a brief 1/2 page analysis that connects the story to your graph.
"Externalities in Action"
A quasi-public good is a resource that provides benefits to the public, but could be restricted. A pure public good remains accessible to everyone virtually all the time.
NEGATIVE EXTERNALITY OF PRODUCTION (EXTERNAL COSTS)
Occurs when:
Production causes external costs to 3rd parties
MSC>MPC
MSC=MPC+external costs
Examples:
factory pollution (carbon footprint)
Government Intervention:
Tax firm to internalize the externality
benefit:
decreases or eliminates externality
problems:
measurement of pollution is nearly impossible
hard to identify polluting firms amount / percentage
taxes often do not stop the pollution
Legislation to ban or restrict output of polluting firms &/or pass environmental standards laws
benefits:
decreases or eliminates externality
problems:
may lead to unemployment
costs of passing and monitoring laws is expensive
Issue tradable carbon/emissions permits (market-based solution via quota ) allowing buying, selling & trading on the market (cap & trade system)
benefits:
may decrease pollution levels from individual firm
problems:
doesn't lead to reduction of pollution from set quota
difficult to measure amount of pollution from firms
Occurs when:
Production creates external benefits to 3rd parties
Education
MSB>MPB (welfare gain)
MPC=MSC (socially efficient)
Examples:
R&D (research & Development - development or adoption of new technology, invention of new medication
Positive Externality of Production (external benefits)
Government Intervention:
Direct government provision or subsidization of R&D
benefit:
improves human capital (short & long-run)
improves firm efficiency & competitiveness (short & long run)
improves social benefits (productive workforce, lower unemployment, lower crime rate, etc.)
problems:
high cost of govt spending for training programs
opportunity cost for government (takes from other funding possibilities)
Provide advanced training/education via the State or Federal govt
benefits:
increases human capital = benefits to society/GDP/etc.
problems:
firms may take advantage of "free training" (free rider)
costs of providing training/education programs is expensive (opportunity cost)
QUESTIONS: NEGATIVE EXTERNALITIES OF PRODUCTION
1) Using diagrams, show how the negative externality can be corrected by the use of:
taxes (analysis)
legislation and regulations that limit the quantity of pollutants (analysis)
2) What are some advantages and disadvantages of each of these types of policy measures? (evaluation)

QUESTIONS: NEGATIVE EXTERNALITY OF CONSUMPTION
1) Using diagrams show how the negative consumption externality can be corrected by the use of:
legislation and regulations that limit the external costs
advertising and persuasion
indirect taxes
2) What are some advantages and disadvantages of each of these policy measures?
Occurs when:
Consumption creates external costs to 3rd parties
MPB>MSB (welfare loss)
Examples:
air pollution (cars, cigarettes)
noise pollution (cars, loud music, dogs barking)
land & water pollution (plastic bags, etc.)
Negative Externality of Consumption (external costs)
Government Intervention:
1) Ban private activity
benefit:
may improve human capital (short & long-run)
may improve societies quality of living
problems:
affect employment within industry
opportunity cost for government (decrease tax revenue opportunity)
government politicians could lose votes
creation of black market
2) Imposition of Indirect Taxes
benefits:
earn tax revenue
decrease negative externalities
problems:
creation of black market
decrease disposable income for highly addicted consumers
3) Education/Negative Advertising
benefits:
provide symmetrical information to all SES segments of society
decrease negative externalities
problems:
opportunity costs for government (decreases funding for other projects)
cost-benefit analysis (questionable results)
Government Intervention:
1) Direct government provision and/or subsidize consumption of merit good
benefit:
improves human capital (short & long-run)
improves social benefits (productive workforce, lower unemployment, lower crime rate, etc.)
problems:
high cost of government spending on merit goods
opportunity cost for government (takes from other funding possibilities)
2) Government funded Positive Advertisement (immunize your child) or Legislation (mandated school attendance)
benefits:
increases human capital = benefits to society (higher economic & social development
problems:
costs of providing training program is expensive (opportunity cost)
long-run benefits (high cost)
infringement on civil liberties
Occurs when:
Consumption creates external benefits to 3rd parties
MSB>MPB (welfare gain)
MSB=MPB(socially efficient)
Examples:
Education, immunizations, planting a tree
Positive Externality of Consumption (external benefits)
Benefits of government subsidized education
Full transcript