1. Market Failure

2. Market Failure Definition:
Where the market mechanism fails to allocate resources efficiently
Social Efficiency
Allocative Efficiency
Technical Efficiency
Productive Efficiency

3. Market Failure
Social Efficiency = where external costs and benefits are accounted for
Allocative Efficiency = where society produces goods and services at minimum cost that are wanted by consumers
Technical Efficiency = production of goods and services using the minimum amount of resources
Productive Efficiency = production of goods and services at lowest factor cost

4. Market Failure Allocative efficiency:
Also referred to as
Pareto Efficient Allocation – resources cannot be readjusted to make one consumer better off without making another worse off – zero opportunity cost!
After Vilfredo Pareto (1848–1923)

5. Market Failure Market Failure occurs where:
Knowledge is not perfect - ignorance
Goods are differentiated
Resource immobility
Market power
Services/goods would or could not be provided in sufficient quantity by the market
Existence of external costs and benefits
Inequality exists

6. Market Failure Imperfect Knowledge:
Consumers do not have adequate technical knowledge
Advertising can mislead or mis-inform
Producers unaware of all opportunities
Producers cannot accurately measure productivity
Decisions often based on past experience rather than future knowledge

7. Market Failure Goods/Services are differentiated Branding
Designer labels - they cost three times as much but are they three times the quality?
Technology – lack of understanding of the impact
Labelling and product information
Which one is the ‘quality’ item and why?

8. Market Failure Resource Immobility Factors are not fully mobile
Labour immobility – geographical and occupational
Capital immobility – what else can we use the Channel Tunnel for?
Land – cannot be moved to where it might be needed, e.g. London and South East!

9. Market Failure Market Power: Existence of monopolies and oligopolies
Collusion
Price fixing
Abnormal profits
Rigging of markets
Barriers to entry

10. Market Failure Inadequate Provision: Merit Goods and Public Goods
Merit Goods – Could be provided by the market but consumers may not be able to afford or feel the need to purchase – market would not provide them in the quantities society needs
Sports facilities?

11. Market Failure Merit Goods
Education – nurseries, schools, colleges, universities – could all be provided by the market but would everyone be able to afford them?
Schools: Would you pay if the state
did not provide them?

12. Market Failure Public Goods
Markets would not provide such goods and services at all!
Non-excludability – Person paying for the benefit cannot prevent anyone else from also benefiting - the ‘free rider’ problem
Non-rivalry –
Large external benefits relative to cost – socially desirable but not profitable to supply!
A non-excludable good?
Would you pay for this?

13. Market Failure De-Merit Goods Goods which society over-produces
Goods and services provided by the market which are not in our best interests!
Tobacco and alcohol
Drugs
Gambling

14. Market Failure External Costs and Benefits External or social costs
The cost of an economic decision to a third party
External benefits
The benefits to a third party as a result of a decision by another party

15. Market Failure External Costs
Decision makers do not take into account the cost imposed on society and others as a result of their decision
e.g. pollution, traffic congestion, environmental degradation, depletion of the ozone layer, misuse of alcohol, tobacco, anti-social behaviour, drug abuse, poor housing

16. External Costs Price Value of the negative externality (Welfare Loss)
MSC = MPC + External Cost
Price
The Marginal Social Benefit curve (MSB) represents the sum of the benefits to consumers in society as a whole – the private and social benefits. The Marginal Private Cost (MPC) curve represents the costs to suppliers of producing a given output.
The true cost therefore is the MSC (the MPC plus the external cost). Current output levels therefore (100) represent some element of market failure – price does not accurately reflect the true cost of production.
The MPC does not take into account the cost to society of production. At an output level of 100, the private cost to the supplier is £5 per unit but the cost to society is higher than this (£12).
The difference between the value of the MSB and the MSC represents the welfare loss to society of 100 units being produced.
MPC
£12
Value of the negative
externality (Welfare Loss)
Social Cost £7 £5
Socially efficient output is where
MSC = MSB
The slide has been designed to try to lead students through the distinction between the private costs of production and the social cost. The diagram starts out with a basic supply and demand position with price at £5 and Quantity at 100. The demand curve has been labelled MSB – a brief explanation of the concept here is useful. The supply curve is the marginal private cost – the cost to the producer. To try to link the theory to the practice it is suggested that the item in question is the production of rolls of Clingfilm! The reason is that in producing cellophane products there is an amount of air pollution. If students are told that the cost to the producer of manufacturing 100 rolls of Clingfilm is £5 (don’t forget to remind them that this figure includes the element of profit they make) but, the company do not take into consideration the cost imposed on society of the pollution they cause. This cost is then highlighted by a dashed line moving up from the bottom and is priced at £12 . The supply curve that considers the true cost (the MPC and MSC) is then drawn in and the right brace appears to indicate the extent of the social cost (£7).
The welfare loss triangle is then imposed – this may need to be explained and students could be reminded of the work done on consumer surplus to help reinforce the concept of the ‘value’ here. Finally, the socially efficient output is highlighted; students can be told that there would be benefits to society if less were produced but that we would be paying more as a result!
MSB 80
100
Quantity Bought and Sold

17. Market Failure External benefits –
by products of production and decision making that raise the welfare of a third party
e.g. education and training, public transport, health education and preventative medicine, refuse collection, investment in housing maintenance, law and order

18. External Benefits Price MSC Value of the positive
There can be a position where output is less than would be socially desirable (education for example?) In this case, the sum of the benefits to society is greater than the private benefit to the individual.
MSC
Value of the positive
externality (Welfare Loss)
£10
Social Benefits
£6.50
Socially efficient output
is where
MSC = MSB £5
This slide looks at
MSB
MPB
100
140
Quantity Bought and Sold

19. Market Failure Inequality: Poverty – absolute and relative
Distribution of factor ownership
Distribution of income
Wealth distribution
Discrimination
Housing

20. Market Failure Measures to correct market failure State provision
Extension of property rights
Taxation
Subsidies
Regulation
Prohibition
Positive discrimination
Redistribution of income