Effectiveness of policies MARKET FAILURE Effectiveness of policies Policies to correct Reasons for failure 5 most important points Deadweight Loss Monopolies

Reasons for Failure • Monopoly Power / Imperfect Competition• Negative Externalities from production and consumption• Positive Externalities from production and consumption• Immobility of Factors of Production (both geographical and occupational)• Market provision of pure Public Goods and quasi Public Goods• Merit Goods and Services and De-Merit Goods• Imperfect and Asymmetric information in markets (leading to information failure)• Missing markets (e.g. absent markets in some environmental resources) Definition of market failure When the operation of a market does not lead to economic efficiency

Monopolies & Market Failure Deadweight Loss Remember the following: MC = MR – Maximum Profit or Minimum Loss MC = AR – Allocative Efficiency (Supply = Demand)AC = AR – Breakeven PointAC = MC – Technical Optimum – Productive Efficiency MC P2 P1 AR MR Q2 Q1

Deadweight loss Loss of Consumer & Producer Surplus S+Indirect Tax Q2 Q1 Loss of Consumer & Producer Surplus

Government Intervention From the AS course: Maximum Prices - Price Stabilisation - Taxes & Subsidies - Direct Provision. Reasons for intervention: Restore economic efficiency - increase equity Failure Consequence Intervention Market Power P↑Q ↓ Competition Policy Merit Goods Underprovided Subsidy Legislation Negative Externalities Overproduced Taxes Legislation Instability Price fluctuations Buffer stocks Inequality unequal distribution Taxes Subsidies

Regulation of monopolies 1. Outlaw formation of Monopolies - Commerce Commission in NZ 2. Predatory Pricing - pricing below competition to eliminate competition 3. Guaranteed quality of goods and services 4. Insist on certain levels of competition in a market

Redistributing Income & Wealth 1. Social Security benefits and pensions. 2. Provision of goods and services 3. Taxation - progressive income tax 4. Legislation - minimum wage and equal pay legislation 5. Training - may improve wages in long term. Equity - Efficiency Trade-Off Intervention in the market by government is to reduce the uneven distribution. Subsidies to lower income groups and taxes on higher income groups maybe regarded as socially desirable but they are interfering with the market and therefore are actually creating inefficiency. BUT - inefficiencies that exist already in the market (externalities monopolies) - intervention may improve efficiency overall.

Problems of Government intervention 1. Lack of Information 2. Difficulty quantifying problems 3. Mistiming 4. Administration costs 5. Political pressure

Exam Questions 4. Large firms necessarily become monopolistic. Monopolies adopt practices that are undesirable. Therefore, large firms should be regulated by governments. Discuss whether there is any truth in this argument. [25] June 2008 Large firms not necessarily monopolisitic - size of market important. Could be a contestable market. Large firm can achieve economies of scale - lower price for consumers. Supernormal profits gives the firm the ability to invest - improve efficiency and R&D May have to innovate to keep competition out BUT Predatory pricing Large can drive up price MC=MR to detriment of consumers - not producing at MC=AR but as MC=MR - DWL - graph here Gov’t regulation depends on market power - needs to have correct information about the market. Will intervention improve efficiency???

Exam Questions 2. In 2007 the UK Competition Commission indicated that failure in the market mechanism would result in both winners and losers. (a) Explain why producers are usually the winners and consumers are usually the losers when the market fails. [12] Market clearing D=S perfect information and perfect markets. Imperfect markets and imperfect information market failure occurs. Monopoly influences with resulting higher profits for producers but higher prices for consumers – and with possibly less choice. Externalities which may affect consumers but would not necessarily have to be accounted for by producers. It could be from a lack of information – it is likely that producers will have more information about the effects of a product than consumers. (b) Discuss what the government might do when there are losers because the market mechanism has failed. [13] June 2010 Regulation, taxation, information, controls etc. For and against here

Exam Questions 4 In India the post is delivered partly by private courier firms and partly by the government-owned India Post. The government is keen to increase its share of the market. (a) Explain why a government might wish to increase its control over private firms. [10] Availability of product to all - private sector restricted services - important for the economy - make it more efficient mention productive and allocative - private sector not allocative - supernormal profits being earned - regulate health and safety issues (b) Discuss whether an increase in government control necessarily improves efficiency in an organisation. [15] Nov 2008 Is it already efficient? If firm restricting output and earning large supernormal profit gov’t intervention needed. Increase consumer surplus move towards allocative efficiency - graph here. Gov’t failure also - lack of information - over estimates negative externalities - high tax might reduce firms from investing etc. Political Popularity ?