Correcting Market Failure Understand what is meant by market failure. Understand that production and consumption can lead to negative externalities. Evaluate policies to correct market failure

Market Failure When the market (through demand and supply) fails to allocate resources in the best interests of society as a whole. Supply & Demand Diagram

Graph By looking at the graph we can see that at £4 there is equilibrium. However, although at equilibrium, we have to ask if the market is failing. At prices of cigarettes of £4.00 does not include the externalities (days of work, sick, rubbish). Therefore we should say that there should be £1.00 tax to cover this, thus increasing the price to £5.00. By doing this we would see a contraction in demand.

In this instance, where the cigarettes are £4 In this instance, where the cigarettes are £4.00, we can say that the market has failed. It has not taken into account the externalities. In summary the market has not allocated its resources in the best possible way.

Economic Question The one point we need to consider in economics is the best way that scarce resources should be allocated. By doing this we must consider ‘How much government intervention there should be?’ What would happen if the markets were left alone? Invisible glove??

Can be broken down into Free market Shared Communist ( total control)

Provision of merit goods What is a merit good? What do you think would happen to the consumption of a merit good in a market economy? We say it would be under consumed. Example: Using previous graph, the market is left to itself and so education is charged at £4000.00. What would happen? In this instance we need to look at the graph from a private point of view.

In this instance people would look at the cost and see what the benefits are of paying for education. Some would say that benefits are able to learn, behaviour, organisation, time keeping……but what is not being taking into account?

The social benefits. People will look at education from a personal point of view and how it benefits them. So once again in this aspect the price of £4000, does not take into account social benefits. You could say that with the external benefits that education is worth an extra £1000 taking it to £5000. Further some just wouldn’t pay for education. Thus we say that the market is under consumed

In this case the government has to get involved due to the external benefits. The government takes control, education is free, as there are so many benefits. This is an example of how a free market might never work.

Demerit Goods With demerit goods the opposite is true. We see that it is over consumed. At £4, the price does not take into account negative externalities. Thus the product, cigarettes, is over consumed. £1 should go and pay for the external costs (and in reality tax does far outweigh these)