2014 jhec market failure and govt intervention (session 3)

Market Failure

• Why is there a need to incinerate our solid waste? Why can’t Singapore have more landfill?

• How much of Singapore’s solid waste is incinerated?

• What are some benefits of incinerating our solid waste?

• What are some costs of incinerating our solid waste?

Debrief of Visit to Tuas South Incinerator Plant

High Opportunity Cost

90%. We only have one landfill in Semakau island

Is it just the revenue gained from incinerating the waste and from the electricity generated from the energy emitted through incineration? Are there are other benefits?

Is it just the private cost of production? Are there additional cost due to the incineration. Possible pollution to the environment leading to higher healthcare cost?

Are we over-consuming?

Should we reduce the amount of waste?

Watch this 20 min online video to find out about the way we make,

use and throw away all the Stuff in our lives.…

The Story of My Stuff

Summarising the video… • Fall in cost of production

→ increase in production and supply of good and services

• Increase income and advertisements → increase in demand for goods and services

• Both increase in demand and supply → increase in consumption of goods and services

→ increase in waste generated

→ increase incineration

→ increase pollution + global warming as the adverse side-effects

→ external cost on society not considered by price mechanism which consider private benefits and costs in their decisions.

→ market failure

→Need for Govt Intervention

Scarcity Limited resources relative

to unlimited wants

Resource allocation What, how & for whom to produce?

Allocation mechanism

Market Economy adopts the Price Mechanism) v.s. Govt directives

Outcome of allocation

What is considered ‘desirable’? Judging criteria?

Characteristics of a Market Economy

• Private ownership of fops

• Economic freedom

– Freedom of choice

– Freedom of enterprise

• Aim is to promote self-interest

– Firm aim to maximise profit

– Consumers aim to maximise satisfaction

• Competition exists

– Among firms, consumers and factor owners

• Use Price Mechanism to allocate resources

How Price Mechanism works to determine what and how much to produce

Mkt SS

Mkt DD

Quantity

Cost / benefit

Qe

Shortage

Consumers express their demand through the prices that they are willing and able to pay

When Price is lower than Pe, there will be a shortage. Shortages cause prices to rise

This gives producers incentives to increase Qty SS

Producers respond to the prices and supply accordingly, based on they are willing and able to accept

When Price is above Pe, there will be a surplus.

Surpluses cause prices to fall

Production becomes less profitable and Qty SS fall

Hence price acts as automatic

signals which coordinates the

actions of consumers and

producers who seek to maximise

their self-interest

Pe

Surplus

But the Price mechanism will achieve

economic efficiency only if the

conditions of a perfect market is met.

In reality the market often fails

Why does market ‘fail’?

How to rectify this ‘failure’?

Any problems with the solutions?

Why Market Fail

market failure

externalities

demerit goods

merit goods

public goods market power

imperfect information

immobility of factors of production

Market failure 1) So what is market failure? Market mechanism fails to allocate resources efficiently

2) What is allocative efficiency? It is the outcome where resources cannot be reallocated to make someone better off without making another worse off.

why does the market fail? Take a closer look at the conditions of a perfect market

1) Many buyers and sellers, assumed to be rational in their decision making

2) No barrier to entry and exit 3) Homogenous goods 4) Perfect information 5) Perfect factor mobility 6) No externalities

why does the market fail? If buyers and sellers are assumed to be rational in their decision making, would they consider external effects on third parties?

No

Government intervention Government intervention to influence the allocation

of scarce resources achieve an improvement in economic and social welfare [rationale of policy].

Types of government intervention? Subsidise / Tax Educate / Regulate Govt Provides / Ban

Taxes This is a charge levied on the producers

by the government in order to discourage them to produce or supply a

certain good or service. How does a tax work? Increases producers’ cost of production more expensive for producers to produce Producer is less willing and able to produce produce less fall in supply leftward shift of supply curve

Price

Quantity

WHO

RATIONALE

IMPACT

Taxes

Assuming that demand remains unchanged fall in supply to S + tax consumers end up paying higher

price of P2

IMPACT

subsidies This is a payment of money by the

government to producers to encourage them to produce and supply a certain good or service. How does a subsidy work? Decreases producers’ cost of production cheaper for producers to produce Producer is more willing and able to produce produce more rise in supply rightward shift of supply curve

Price

Quantity

IMPACT

WHO

RATIONALE

subsidies Assuming that

demand remains unchanged rise in supply to S + subsidy consumers end

up paying lower price of P2

IMPACT

Evaluation of Taxes FRESH

F – Feasibility R – Root cause

E – Effectiveness S – Side effects H – time Horizon

CRITERIA

Consequences / Impact / Effects

+ve impact E – It is adjustable.

S – It provides government with revenue which can be used to finance other types of expenditure (healthcare, education etc.)

-ve impact / limitations

F – Difficult to impose taxes as it is politically unfeasible.

E – Difficult to determine exact amount of tax as the required info. is too vast. If tax is too little or too much economy moves from one inefficient allocation to another, w/o necessarily improving the situation

E – How much quantity is is uncertain

S – output by firms may UN

Evaluation of subsidies FRESH

F – Feasibility R – Root cause

E – Effectiveness S – Side effects H – time Horizon

CRITERIA

Consequences / Impact / Effects

+ve impact S – Increased output by firms may raise employment level

S – May improve equity, thus ensuring that citizens’ welfare is taken care of by the government’s action.

-ve impact / limitations F – Difficult to remove subsidies in the future once it has been implemented.

E – Difficult to determine exact amount of subsidy due to imperfect info. If the government assesses wrongly the amount resource misallocation

E – How much quantity is is uncertain

S – Govt spends less elsewhere opportunity cost of that subsidy in terms of other government projects forgone.

takeaways • What is market failure? • Why does the market fail? • Why do governments intervene? Is it just to

correct market failure? • Implications of government intervention? • Is government intervention always desirable?

think about this!