NS3040 Fall Term 2018 Market Failure/Cost Benefits

Market Failures I A market failure is a situation where free markets fail to allocate resources efficiently due to: Monopoly power Markets may fail to control for the abuses of monopoly power Missing markets Markets may fail to meet a need or want, such as the need for public goods, such as defense street lighting and highways With defense free rider problem Incomplete markets Markets may fail to produce enough merit goods, such as education and health care

Market Failures II De-Merit Goods Negative externalities Markets may fail to control for manufacture and sale of goods like cigarettes and alcohol, which have less merit than consumers perceive Negative externalities Consumers and producers may fail to take into account the effects of their actions on third-parties – pollution, excess noise. Train case and liability Positive externalities Beneficiary does not have to pay – bee problem Learning on the job – changing jobs

Market Failures III Property rights Information failure Markets work most efficiently when consumers and producer granted the right to own property Many cases property rights cannot be easily allocated to certain resources – limits ability of market to function – access to credit Information failure Markets may not provide enough information during a market transition It may not be in the interests of one party to provide full information to the other party – lemon problem Unstable markets Sometimes markets become highly unstable and equilibrium may not be established

Market Failures IV

Market Failures V Remedies: Two basic strategies Use price mechanism Increasing price of “harmful” products taxation Subsidies for “beneficial” products Use legislation and force Licensing system for alcohol, penalizing polluters Often both used in varying combinations

Consumer and Producer Surplus

Correcting for Externalities

Trade Example of Cost-Benefit

Trade: Complete Picture