market failure and government policy market failure and government policy a’lam asadov...
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Market Failure
And
Government Policy
Market Failure
And
Government Policy
A’lam Asadov
Markets and the Role of GovernmentMarkets and the Role of Government
• Government intervention and social objectives
• The objective of social efficiency– marginal social benefits and costs
• MSB > MSC produce (or consume) more• MSC > MSB produce (or consume) less
– socially efficient output where MSB = MSC• Equity
– concepts of fairness• Trade-offs between equity and efficiency
• Government intervention and social objectives
• The objective of social efficiency– marginal social benefits and costs
• MSB > MSC produce (or consume) more• MSC > MSB produce (or consume) less
– socially efficient output where MSB = MSC• Equity
– concepts of fairness• Trade-offs between equity and efficiency
Types of Market FailureTypes of Market Failure
• Externalities
– An externality refers to the uncompensated impact of one person’s actions on the well-being of a bystander.
– Externalities cause markets to be inefficient, and thus fail to maximize total surplus.
– There are two types of externalities:
Negative and Positive externalities
• Externalities
– An externality refers to the uncompensated impact of one person’s actions on the well-being of a bystander.
– Externalities cause markets to be inefficient, and thus fail to maximize total surplus.
– There are two types of externalities:
Negative and Positive externalities
Externalities and Market Failure Externalities and Market Failure
• Negative Externalities– Automobile exhaust– Cigarette smoking– Barking dogs (loud pets)– Loud stereos in an apartment building
• Negative Externalities– Automobile exhaust– Cigarette smoking– Barking dogs (loud pets)– Loud stereos in an apartment building
Externalities and Market FailureExternalities and Market Failure
• Positive Externalities– Education– Restored historic buildings– Research into new technologies
• Positive Externalities– Education– Restored historic buildings– Research into new technologies
Types of Market FailureTypes of Market Failure
• Externalities in production
– External costs of production MSC > MC
– External benefits of production MSC < MC
• Externalities in production
– External costs of production MSC > MC
– External benefits of production MSC < MC
Q1
External costs in productionExternal costs in production
O
MC = S
DP
Co
sts
and
be
nef
its
Quantity
O
MC = S
DP
MSC
Co
sts
and
be
nef
its
Quantity
External cost
Q1Q2
Social optimum
External costs in productionExternal costs in production
External benefits in productionExternal benefits in production
O
DP
MC = S
Q1
Co
sts
and
be
nef
its
Quantity
O
MSC
DP
Q1
External benefit
Co
sts
and
be
nef
its
Quantity
MC = S
Q2Social optimum
External benefits in productionExternal benefits in production
O
MC = S
DP
Q1Q2
Cos
ts a
nd b
enef
its (
£)
Quantity
MSC
External cost
(a ) External costs
O
DP
Q2Q1
Cos
ts a
nd b
enef
its (
£)
Quantity
MSCMC = S
External benefit
(b) External benefits
External costs and benefits in productionExternal costs and benefits in production
Types of Market FailureTypes of Market Failure
• Externalities in consumption
– External costs of consumption MSB < MB
– External benefits of consumption MSB > MB
• Externalities in consumption
– External costs of consumption MSB < MB
– External benefits of consumption MSB > MB
O
MB
PP
Cos
ts a
nd b
enef
its (
£)
Car miles
MSB
External cost
O
MB
PP
Q1
Cos
ts a
nd b
enef
its (
£)
Rail miles
Q2
MSB
External benefit
(a ) External costs (b) External benefits
External costs and benefits in consumptionExternal costs and benefits in consumption
Q1Q2
Types of Market FailureTypes of Market Failure
• Public goods
– non-rivalry
– non-excludability and the free-rider problem
• Public goods
– non-rivalry
– non-excludability and the free-rider problem
Public vs. Private goods Public vs. Private goods
Goods can be classified according to two attributes:
whether they are excludable and
whether they are rival in consumption
A good is excludable if the supplier of that good can prevent people who do not pay from consuming it.
A good is rival in consumption if the same unit of the good cannot be consumed by more than one person at the same time.
Characteristics of GoodsCharacteristics of Goods
There are four types of goods:
Private goods, which are excludable and rival in consumption, like bread or personal computer
Public goods, which are non-excludable and non-rival in consumption, like a public sewer system
Common resources, which are non-excludable but rival in consumption, like clean water in a river
Artificially scarce goods, which are excludable but non-rival in consumption, like pay-per-channel Satellite broadcasting.
There are four types of goods. The type of a good depends on (1) whether or not it is excludable— whether a producer can prevent someone from consuming it; and (2) whether or not it is rival in consumption—whether it is impossible for the same unit of a good to be consumed by more than one person at the same time.
Types of Market FailureTypes of Market Failure
• Market power
– lack of social efficiency
– deadweight welfare loss under monopoly
• Market power
– lack of social efficiency
– deadweight welfare loss under monopoly
O
£
Q
Ppc
Qpc
AR = D
Consumersurplus
Producersurplus
MC(= S under perfect competition)
(a) Industry equilibrium under perfect competition
a
Perfectcompetition
Deadweight loss under monopolyDeadweight loss under monopoly
MRO
£
Q
Ppc
Qpc
AR = D
a
Qpc
Pm
bConsumer
surplus
Producersurplus
Deadweightwelfare loss
MC(= S under perfect competition)
(b) Industry equilibrium under monopoly
Monopoly
Deadweight loss under monopolyDeadweight loss under monopoly
Types of Market FailureTypes of Market Failure
• Ignorance and uncertainty
– by consumers
– by firms
• Immobility of factors and time lags
• Protecting people’s interests
– dependants
– merit goods
• Ignorance and uncertainty
– by consumers
– by firms
• Immobility of factors and time lags
• Protecting people’s interests
– dependants
– merit goods
Government Intervention in the MarketGovernment Intervention in the Market
• Taxes and subsidies– to correct externalities
• Taxes and subsidies– to correct externalities
Q1O
MC = S
DP
Co
sts
and
be
nef
its
Quantity
Using taxes to correct a market distortionUsing taxes to correct a market distortion
O
MC = S
DP
MSC
Co
sts
and
be
nef
its
Quantity
External cost
Q1Q2
Social optimum
Using taxes to correct a market distortionUsing taxes to correct a market distortion
Q2
MC
Q1O
P
Co
sts
and
be
nef
its
Quantity
Optimum tax = MSC – MC
MC = SMSC
D
Using taxes to correct a market distortionUsing taxes to correct a market distortion
O
DP
MC = S
Q1
Co
sts
and
be
nef
its
Quantity
Using subsidies to correct a market distortionUsing subsidies to correct a market distortion
O
MSC
DP
Q1
External benefit
Co
sts
and
be
nef
its
Quantity
MC = S
Q2Social optimum
Using subsidies to correct a market distortionUsing subsidies to correct a market distortion
MC
O
P
Q2Q1
Co
sts
and
be
nef
its
Quantity
Optimum subsidy
= MC – MSC
MSCMC = S
D
Using subsidies to correct a market distortionUsing subsidies to correct a market distortion
Government Intervention in the MarketGovernment Intervention in the Market
• Taxes and subsidies (cont.)– to correct for monopoly
• use of lump-sum taxes plus subsidies
– advantages of taxes and subsidies• can vary the rate according to the size of the
market distortion
– disadvantages of taxes and subsidies• infeasible to use different tax and subsidy rates
• lack of knowledge
• Taxes and subsidies (cont.)– to correct for monopoly
• use of lump-sum taxes plus subsidies
– advantages of taxes and subsidies• can vary the rate according to the size of the
market distortion
– disadvantages of taxes and subsidies• infeasible to use different tax and subsidy rates
• lack of knowledge
Government Intervention in the MarketGovernment Intervention in the Market
Other forms of government intervention• Changes in property rights
– the problem of limited property rights
– extending property rights
– limitations of this solution
• Laws prohibiting behaviour that imposes external costs
– advantages of legal restrictions
– disadvantages of legal restrictions
• Regulatory bodies
Other forms of government intervention• Changes in property rights
– the problem of limited property rights
– extending property rights
– limitations of this solution
• Laws prohibiting behaviour that imposes external costs
– advantages of legal restrictions
– disadvantages of legal restrictions
• Regulatory bodies
Government Intervention in the MarketGovernment Intervention in the Market
Other forms of government intervention (continued)
• Price controls– high minimum prices– low maximum prices
• Provision of information• Direct provision of goods and services
– justification• social justice• large positive externalities• dependants• ignorance
Other forms of government intervention (continued)
• Price controls– high minimum prices– low maximum prices
• Provision of information• Direct provision of goods and services
– justification• social justice• large positive externalities• dependants• ignorance
More or less intervention?More or less intervention?
• Drawbacks of government intervention– shortages and surpluses
– poor information
– bureaucracy and inefficiency
– lack of market incentives
– shifts in government policy
– voters’ ignorance
– unrepresentative government
– lack of freedom for the individual
• Drawbacks of government intervention– shortages and surpluses
– poor information
– bureaucracy and inefficiency
– lack of market incentives
– shifts in government policy
– voters’ ignorance
– unrepresentative government
– lack of freedom for the individual
Private Solutions to ExternalitiesPrivate Solutions to Externalities
• Government action is not always needed to solve the problem of externalities.
There might be some private solutions to externalities such as:
• Moral codes and social sanctions• Charitable organizations• Integrating different types of businesses• Contracting between parties
• Government action is not always needed to solve the problem of externalities.
There might be some private solutions to externalities such as:
• Moral codes and social sanctions• Charitable organizations• Integrating different types of businesses• Contracting between parties
Question ???Question ???