8/7/2019 revision notes fr market failure

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Revision Notes for Market Failure

Type (A): Externality + Imperfect knowledge and/ or equityPart (a): Explanation of the various sources of market failureIntroduction

Scarcity (unlimited wants + limited resources)

Need to allocate resources efficiently.

How? Economic efficiency (comprised of productive efficiency and allocative efficiency) In the case of market failure, emphasis is on allocative efficiency (MSB=MSC) (define)

In the event if there is misallocation of resources market failure exists (define)Negative Externality (smoking/ traffic congestion/ pollution)

Define negative externality

Define, explain and illustrate MPC and MEC

Divergence between MPC and MSC

Illustrate using a diagram (assuming there is no positive externality)

Explain what happens in an unregulated market and where is the socially optimal level of output

Hence, due to over-consumption/ production results in deadweight lossPositive Externality (education/ housing/ healthcare) Define positive externality

Define, explain and illustrate MPB and MEB

Divergence between MPB and MSB

Illustrate using a diagram (assuming there is no negative externality)

Explain what happens in an unregulated market and where is the socially optimal level of output

Hence, due to under-consumption/ production results in deadweight lossOther sources of market failure could include imperfect knowledge and/ or equity

Define imperfect knowledge

Explain the causes of imperfect knowledge which leads to market failure

Explain equity

Part (b): Discussion of the various policies to tackle the problem of externalityNegative externality

Taxation (explain using a diagram)

Legislation

Moral suasion

Tradable permits (for pollution)

Nationalisation

Positive externality Grants (explain using a diagram)

Subsidies (explain using a diagram)

Legislation

Moral suasion

Limitations/ Evaluations of the policiesPositive Externality

Sweet are the uses of adversity, which like the toad, ugly and venomous, wears yet a precious jewel in hishead

8/7/2019 revision notes fr market failure

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Revision Notes for Market Failure

Difficult to estimate the level of external benefits level of subsidies/ grants may not be adequate too high a grant/ subsidy may lead to substantial wastage Government may need to impose higher taxes to finance the spending adverse effects on the

economy

For legislation to be effective, there must be some form of monitoring and the costs involvedshould be kept low for the implementation

For moral suasion, the effectiveness of persuasion is not certain since it is voluntary

Negative Externality

Difficult to estimate the amount of tax + there is administrative costs incurred in collecting thetaxes

For tradable permits provides incentives to create and use less polluting technologies + difficultfor government to determine the optimal quantity of pollution

For legislation, cost of intervention may be high because of the administrative costs incurred inmonitoring and enforcing compliance with the legislation

Legislation does not provide incentives for firms to further reduce their external costs

Government may create inefficiencies when they intervene through direct production as it may not

produce the efficient level of output even with nationalization. Besides, the government may nothave adequate resources

For moral suasion, the effectiveness of persuasion is not certain since it is voluntary

Type (B): Market dominance (usually comes in the form of a market structure question)

In the absence of externality allocative efficiency is achieved when P=MC For Monopoly, monopolistic competition and oligopoly, when MR=MC, at the Qe, P>MC under-

allocation of resources allocative efficiency is not achieved market fails Ways to correct this form of market failure price regulations/ legislations/ etc.Type (C): Public Goods

Define public goods Explain non-rivalry and non-excludability

Implications of non-rivalry and non-excludability

o MC=0 P=0 There is no market for this good since the private will not be willing toprovide it for free need for government intervention

o Problem of free-rider people who do not pay for the good can also get to consume it price mechanism fails to provide the producer with an effective means to exclude

people who do not pay from consuming the good the market will not produce theneed for government intervention

Sweet are the uses of adversity, which like the toad, ugly and venomous, wears yet a precious jewel in hishead