1. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 1 Chapter 17 Market Failure and Resource Allocation

2. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 2 Learning Objectives Discuss the nature, and provide examples of, spillovers (externalities). Examine the implications of spillovers for the efficient allocation of resources. Briefly discuss the problem of the commons and its implications. Describe the characteristics of public goods and the potential role of government in ensuring the adequate provisions of these goods.

3. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 3 Learning Objectives (cont.) Show how we can evaluate government activity through cost–benefit analysis. Determine the economic considerations that underlie environmental problems and examine some suggested solutions to the pollution problem.

4. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 4 Sources of Market Failure Produce the wrong amounts of goods or services, resulting in externalities or ‘spillover’ effects Failure to allocate sufficient resources to the production of certain goods, called ‘public’ or ‘social’ goods

5. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 5 Spillovers or Externalities Costs or benefits associated with the production or consumption of a good or service that flow on to parties that are external to the market transaction Spillovers – costs or benefits associated with production or consumption that flow on to parties external to the market transaction – the market over-allocates resources

6. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 6 Spillover Costs Q 0 D P QeQe Qo Qo S1S1S1S1 S

7. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 7 Spillovers or Externalities Spillover Benefits Production or consumption of goods and services which confer external benefits for which payment or compensation is not required The market under-allocates resources

8. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 8 Spillover Benefits Q 0 PS Qo Qo QeQe D D1D1D1D1

9. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 9 Public Goods and Services Private goods are produced through the market system – divisible – exclusion principle Public goods not provided by the market and are: – indivisible – not subjected to the exclusion principle

10. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 10 P Q D When vertically added equals collective willingness to pay D2D2 D1D1 Demand for a Public GoodS

11. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 11 Solutions to Market Failure Correcting for spillover costs Legislation Specific taxes Property rights and individual bargaining – Coase theorem  Property ownership is clearly defined  The number of people involved is small  Bargaining costs are negligible

12. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 12 P Q D 0 Spillover costs StSt S TAX Over-allocation corrected Q0Q0 QeQe Correcting for Spillover Costs

13. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 13 Correcting for Spillover Benefits Subsidise buyers Subsidise producers

14. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 14 Correcting for Spillover Benefits (cont.) P Q D S 0 DtDt Subsidy to consumer Under-allocationcorrected

15. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 15 P Q D 0 Subsidy to producers increases supply StSt S′tS′t Under-allocation corrected QeQe Q0Q0 Correcting for Spillover Benefits

16. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 16 Allocating Resources to Public Goods Cost–Benefit Analysis method used to allocate resources to public goods that maximises society’s welfare problems associated with cost–benefit analysis include the difficulties in measuring the value of certain costs and benefits in practice

17. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 17 The Pollution Problem The law of conservation of matter and energy Four important causes of pollution 1. Population density 2. Rising incomes 3. Technology 4. Incentives

18. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 18 Anti-Pollution Policies Individual bargaining and liability rules and lawsuits Government intervention: direct control and taxes – Direct controls: legislated standards – Specific taxes: emission fees Establishment of a market for pollution rights

19. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 19 Market for Pollution Rights Involves the establishment of an allowable amount of pollution—in line with the ability of the environment to recycle—by a pollution control agency, and the development of a set of ‘rights’ to create units of pollution which would be sold or auctioned in the market

20. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 20 Market for Pollution Rights (cont.) 500 750 1000 Quantity of pollution rights (units) Price per pollution right $100 $500 D 2000 D 2008 S

21. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 21 Next Chapter: Inequality and Poverty