Chapter - 2.10.2
Pages Red - 69-70
Market Failure occurs when free market activity results in a less than optimum allocation of resources from the point of view of society
Causes Of Market Failure
Demerit Goods
These are goods which have harmful impacts on consumers/society
They are often addictive
E.g. Gambling, alcohol, drugs, sugary foods/drinks
They are over-provided in a market and their consumption often creates external costs
Governments often have to regulate these goods in such a way that they raise the prices and/or limit the quantities consumed
Merit Goods
These are goods that are beneficial to society but consumers under-consume them as they do not fully recognize the private or external benefits
E.g. Vaccinations, education, electric cars
They are under-provided in a market & their consumption generates both private and/or external benefits
Governments often have to subsidies these goods in order to lower the price and/or increase the quantities consumed
Public Goods
Public goods are beneficial to society but would be under-provided by a free market as there is little opportunity for sellers to make profits from providing these goods/services as they are non-excludable and non-rivalrous in consumption
Good examples include national defense, parks, libraries and lighthouses
Non-excludability refers to the inability of private firms to exclude certain customers from using their products. In effect, the price mechanism cannot be used to exclude customers e.g. street lighting
Non-rivalry refers to the inability of the product to be used up, so there is no competitive rivalry in consumption to drive up prices and generate profits for firms
Therefore, governments will often provide these beneficial goods themselves, and so they are called public goods
Abuse of Monopoly Power
The development of monopoly markets is a natural outcome of a market system
Firms seek to eliminate competition by buying out competitors & increasing their ownership of factors of production
With less competition, firms can raise prices, reduce the choice available to consumers, or limit the supply
The outcome is that goods/services are purposely under-provided in order to raise prices and profits
Governments often intervene to ensure that there is healthy competition in markets & sufficient provision of goods/services
Factor Immobility
Factor immobility occurs when it is difficult for factors of production to move or switch between different uses/locations
The two main types of factor immobility are the geographical & occupational immobility of labor
Factor immobility results an inefficient allocation of resources in a market (usually under-provision)
Governments often implement programs to reduce the factor immobility in order to raise production & output
External Costs & Benefits
Externalities occur when there is an external cost or benefit on a third party not involved in the economic transaction
These impacts can be positive or negative
The price mechanism in a free market ignores these externalities
If these external costs/benefits were acknowledged, then the price and output in the market would be different
A positive externality of consumption occurs when there is a positive external benefit in consumption, such as when electric vehicles are consumed CO2 emissions fall
A positive externality of production occurs when there is a positive external benefit in production, such as when managed pine forests produce timber but also increase CO2 absorption
A negative externality of consumption occurs when there is an external cost in consumption such as when the consumption of alcohol increases anti social behavior
A negative externality of production occurs when there is an external cost in production such as when the production of electricity increases air pollution