Market Failures
and Government
Policy
Market Failures
and Government
Market Failures: Externalities and Public Goods
Market Failures: Externalities and Public Goods
•
Society's microeconomic objectives
– equity
– social efficiency
• marginal social benefits and costs
• production where MSB = MSC
•
Society's microeconomic objectives
– equity
– social efficiency
• marginal social benefits and costs
Market Failures: Externalities and Public Goods
Market Failures: Externalities and Public Goods
•
Externalities
•
External costs of production
– MSC > MC
•
Externalities
•
External costs of production
Q1
External costs in production
External costs in production
O
MC = S
D
P
C
o
st
s
a
nd
b
en
ef
its
O
External costs in production
•
Externalities
– External costs of production • MSC > MC
– External benefits of production • MSC < MC
•
Externalities
– External costs of production
• MSC > MC
– External benefits of production
• MSC < MC
External benefits in production
External benefits in production
O
D
P
MC = S
Q1
C
o
st
s
a
nd
b
en
ef
its
O
External benefits in production
O
(a ) External costs
O
(b) External benefits
External costs and benefits in production
•
Externalities
– External costs of production • MSC > MC
– External benefits of production • MSC < MC
– External costs of consumption
•
Externalities
– External costs of production
• MSC > MC
– External benefits of production
• MSC < MC
– External costs of consumption
•
Externalities
– External costs of production • MSC > MC
– External benefits of production • MSC < MC
– External costs of consumption • MSB < MB
•
Externalities
– External costs of production
• MSC > MC
– External benefits of production
• MSC < MC
– External costs of consumption
• MSB < MB
Q1
(MB) MU = D
External costs in consumption
External costs in consumption
O
D
P
C
o
st
s
a
nd
b
en
ef
its
Q2
External costs in consumption
External costs in consumption
•
Externalities
– External costs of production • MSC > MC
– External benefits of production • MSC < MC
– External costs of consumption • MSB < MB
– External benefits of consumption
•
Externalities
– External costs of production
• MSC > MC
– External benefits of production
• MSC < MC
– External costs of consumption
• MSB < MB
– External benefits of consumption
•
Externalities
– External costs of production • MSC > MC
– External benefits of production • MSC < MC
– External costs of consumption • MSB < MB
– External benefits of consumption • MSB > MB
•
Externalities
– External costs of production
• MSC > MC
– External benefits of production
• MSC < MC
– External costs of consumption
• MSB < MB
– External benefits of consumption
• MSB > MB
(MB) MU = D
O
D
P
Q1
C
o
st
s
a
nd
b
en
ef
its
Quantity
External benefits in consumption
Q2
External benefits in consumption
External benefits in consumption
O
(a ) External costs (b) External benefits
External costs and benefits in consumption
External costs and benefits in consumption
•
Externalities
– External costs of production • MSC > MC
– External benefits of production • MSC < MC
– External costs of consumption • MSB < MB
– External benefits of consumption • MSB > MB
•
Public goods
•
Externalities
– External costs of production
• MSC > MC
– External benefits of production
• MSC < MC
– External costs of consumption
• MSB < MB
– External benefits of consumption
• MSB > MB
•
Public goods
•
Externalities
– External costs of production • MSC > MC
– External benefits of production • MSC < MC
– External costs of consumption • MSB < MB
– External benefits of consumption • MSB > MB
•
Public goods
– non rivalry
•
Externalities
– External costs of production
• MSC > MC
– External benefits of production
• MSC < MC
– External costs of consumption
• MSB < MB
– External benefits of consumption
• MSB > MB
•
Public goods
– non rivalry
•
Externalities
– External costs of production • MSC > MC
– External benefits of production • MSC < MC
– External costs of consumption • MSB < MB
– External benefits of consumption • MSB > MB
•
Public goods
– non rivalry
– non-excludability
•
Externalities
– External costs of production
• MSC > MC
– External benefits of production
• MSC < MC
– External costs of consumption
• MSB < MB
– External benefits of consumption
• MSB > MB
•
Public goods
– non rivalry
– non-excludability
Market Failures: Monopoly Power
Market Failures: Monopoly Power
•
The demand curve under monopoly
– production at less than the social optimum
•
The demand curve under monopoly
MC1
Q1
MC
MR AR
A monopolist producing less than the social optimum
A monopolist producing less than the social optimum
O
P1
£
Monopoly output
O
P1
MC1
MC = MSC
Q1
MR AR = MSB
Q2 P2 = MSB
= MSC
£
Q
Monopoly output Perfectly competitive output
A monopolist producing less than the social optimum
Market Failures: Monopoly Power
Market Failures: Monopoly Power
•
The demand curve under monopoly
– production at less than the social optimum
•
Deadweight loss under monopoly
– consumer and producer surplus • consumer surplus
•
The demand curve under monopoly
– production at less than the social optimum
•
Deadweight loss under monopoly
– consumer and producer surplus
•
The demand curve under monopoly
– production at less than the social optimum
•
Deadweight loss under monopoly
– consumer and producer surplus • consumer surplus
• producer surplus
•
The demand curve under monopoly
– production at less than the social optimum
•
Deadweight loss under monopoly
– consumer and producer surplus
• consumer surplus • producer surplus
•
The demand curve under monopoly
– production at less than the social optimum
•
Deadweight loss under monopoly
– consumer and producer surplus • consumer surplus
• producer surplus • total surplus
•
The demand curve under monopoly
– production at less than the social optimum
•
Deadweight loss under monopoly
– consumer and producer surplus
• consumer surplus • producer surplus • total surplus
O
£
Q
Ppc
Qpc
AR = D
Consumer surplus
Producer surplus
Deadweight loss under monopoly
Deadweight loss under monopoly
MC
(= S under perfect competition)
(a) Industry equilibrium under perfect competition
•
The demand curve under monopoly
– production at less than the social optimum
•
Deadweight loss under monopoly
– consumer and producer surplus • consumer surplus
• producer surplus • total surplus
– the effect of monopoly on total surplus
•
The demand curve under monopoly
– production at less than the social optimum
•
Deadweight loss under monopoly
– consumer and producer surplus
• consumer surplus • producer surplus • total surplus
– the effect of monopoly on total surplus
MR
Deadweight loss under monopoly
Deadweight loss under monopoly
MC
(= S under perfect competition)
(b) Industry equilibrium under monopoly
O
£
Q
Ppc
Qpc
AR = D
Consumer surplus
Producer surplus
MC
(= S under perfect competition)
(a) Industry equilibrium under perfect competition
(a) Industry equilibrium under perfect competition a
Perfect competition
Deadweight loss under monopoly
MR
(= S under perfect competition)
(b) Industry equilibrium under monopoly
(b) Industry equilibrium under monopoly
Monopoly
Deadweight loss under monopoly
•
The demand curve under monopoly
– production at less than the social optimum
•
Deadweight loss under monopoly
– consumer and producer surplus • consumer surplus
• producer surplus • total surplus
– the effect of monopoly on total surplus
•
Other problems with monopoly
•
The demand curve under monopoly
– production at less than the social optimum
•
Deadweight loss under monopoly
– consumer and producer surplus
• consumer surplus • producer surplus • total surplus
– the effect of monopoly on total surplus
•
Other problems with monopoly
•
The demand curve under monopoly
– production at less than the social optimum
•
Deadweight loss under monopoly
– consumer and producer surplus • consumer surplus
• producer surplus • total surplus
– the effect of monopoly on total surplus
•
Other problems with monopoly
•
Possible advantages from monopoly
•
The demand curve under monopoly
– production at less than the social optimum
•
Deadweight loss under monopoly
– consumer and producer surplus
• consumer surplus • producer surplus • total surplus
– the effect of monopoly on total surplus
•
Other problems with monopoly
•
Possible advantages from monopoly
Other Market Failures
Other Market Failures
•
Ignorance and uncertainty
•
Immobility of factors and time lags
•
Protecting people's interests
– dependants
– the principal–agent problem
• the problem of asymmetric information • the need for monitoring
– poor economic decision making by people • merit goods
•
Macroeconomic goals
•
Economists and policy advice
•
Ignorance and uncertainty
•
Immobility of factors and time lags
•
Protecting people's interests
– dependants
– the principal–agent problem
• the problem of asymmetric information • the need for monitoring
– poor economic decision making by people
• merit goods
•
Macroeconomic goals
Government Intervention: Taxes and Subsidies
Government Intervention: Taxes and Subsidies
•
The use of taxes and subsidies to
correct externalities
– the optimum size of a tax
•
The use of taxes and subsidies to
correct externalities
Q1
O
MC = S
D
P
C
o
st
s
a
nd
b
en
ef
its
Quantity
Using taxes to correct a market distortion
O
Using taxes to correct a market distortion
Q2
Using taxes to correct a market distortion
•
The use of taxes and subsidies to
correct externalities
– the optimum size of a tax
– the optimum size of a subsidy
•
The use of taxes and subsidies to
correct externalities
– the optimum size of a tax
– the optimum size of a subsidy
O
D
P
MC = S
Q1
C
o
st
s
a
nd
b
en
ef
its
Quantity
Using subsidies to correct a market distortion
O
Using subsidies to correct a market distortion
MC
Using subsidies to correct a market distortion
•
The use of taxes and subsidies to
correct for monopoly
– use of lump-sum taxes
•
Advantages of taxes and subsidies
•
Disadvantages of taxes and subsidies
– infeasible to use different tax and subsidy rates
– lack of knowledge
•
The use of taxes and subsidies to
correct for monopoly
– use of lump-sum taxes
•
Advantages of taxes and subsidies
•
Disadvantages of taxes and subsidies
– infeasible to use different tax and subsidy rates
– lack of knowledge
Government Intervention: Laws and Regulation
Government Intervention: Laws and Regulation
•
The use of laws and regulation
•
Advantages of legal restrictions
– simple to understand
– safer when size of problem is potentially great
– quick to implement
– a good way of dealing with imperfect information
•
Disadvantages of legal restrictions
– a 'blunt weapon'
•
The use of laws and regulation
•
Advantages of legal restrictions
– simple to understand
– safer when size of problem is potentially great
– quick to implement
– a good way of dealing with imperfect
information
•
Disadvantages of legal restrictions
• Types of regulation
• The system of regulation in the UK – UK regulatory bodies
– price-cap regulation
• the RPI–X formula
• Advantages of the UK system – discretionary
– flexible
– incentive for firms to reduce costs • Disadvantages of the UK system
• Types of regulation
• The system of regulation in the UK
– UK regulatory bodies
– price-cap regulation
• the RPI–X formula
• Advantages of the UK system
– discretionary
– flexible
– incentive for firms to reduce costs
• Disadvantages of the UK system
Government Intervention: Laws and Regulation
Other Forms of Government Intervention
Other Forms of Government Intervention
• Changes in property rights
– the problem of limited property rights – extending property rights
– limitations of this solution
• impractical in many situations
• problems of litigation
• questions of equity
• Provision of information – consumer information
– information on jobs – information to firms
• Changes in property rights
– the problem of limited property rights
– extending property rights
– limitations of this solution
• impractical in many situations
• problems of litigation
• questions of equity
• Provision of information
– consumer information
– information on jobs
Other Forms of Government Intervention
Other Forms of Government Intervention
•
Direct provision of goods and services
– the provision of public goods
– the need to evaluate costs and benefits of publicly provided goods
– the provision of other goods and services by the government
• social justice
• large positive externalities • dependants
• ignorance
•
Direct provision of goods and services
– the provision of public goods
– the need to evaluate costs and benefits of publicly provided goods
– the provision of other goods and services by the government
• social justice
• large positive externalities • dependants
More or Less Intervention?
More or Less Intervention?
•
Drawbacks of government intervention
– shortages and surpluses
– poor information
– bureaucracy and inefficiency
– lack of market incentives
– shifts in government policy
– lack of freedom for the individual
•
Drawbacks of government intervention
– shortages and surpluses
– poor information
– bureaucracy and inefficiency
– lack of market incentives
– shifts in government policy
More or Less Intervention?
More or Less Intervention?
• Advantages of the free market – automatic adjustments
– dynamic advantages of capitalism
– possibly high degree of competition even under monopoly/oligopoly
– Judging the arguments
• Should there be more or less intervention in the market?
– important to consider both costs and benefits of intervention
– moral issues
– problem of predicting effects of intervention
• Advantages of the free market
– automatic adjustments
– dynamic advantages of capitalism
– possibly high degree of competition even under monopoly/oligopoly
– Judging the arguments
• Should there be more or less intervention in the market?
– important to consider both costs and benefits of intervention
– moral issues
The Environment: a Case Study
The Environment: a Case Study
•
The environmental problem
– global and local environmental problems
– causes of the problems
•
Market failures
– environment as a common resource
– externalities
– ignorance
– inter-generational problems
•
The environmental problem
– global and local environmental problems
– causes of the problems
•
Market failures
– environment as a common resource
– externalities
– ignorance
The Environment: a Case Study
The Environment: a Case Study
•
Policy alternatives
– charging for use of the environment • emissions charges
•
Policy alternatives
– charging for use of the environment
MB = MSB
L2 L1
P2
MSC
Level of emission
C
An emissions charge
The Environment: a Case Study
The Environment: a Case Study
•
Policy alternatives
– charging for use of the environment • emissions charges
• user charges
•
Policy alternatives
– charging for use of the environment
The Environment: a Case Study
The Environment: a Case Study
•
Policy alternatives
– charging for use of the environment • emissions charges
• user charges
• optimum charge = external cost
•
Policy alternatives
– charging for use of the environment
• emissions charges • user charges
The Environment: a Case Study
The Environment: a Case Study
•
Policy alternatives
– charging for use of the environment • emissions charges
• user charges
• optimum charge = external cost – green taxes and subsidies
•
Policy alternatives
– charging for use of the environment
• emissions charges • user charges
• optimum charge = external cost
The Environment: a Case Study
The Environment: a Case Study
•
Policy alternatives
– charging for use of the environment • emissions charges
• user charges
• optimum charge = external cost – green taxes and subsidies
• use of such taxes around the world
•
Policy alternatives
– charging for use of the environment
• emissions charges • user charges
• optimum charge = external cost
– green taxes and subsidies
Green tax revenues as a % of GDP
Green tax revenues as a % of GDP
The Environment: a Case Study
The Environment: a Case Study
•
Policy alternatives
– charging for use of the environment • emissions charges
• user charges
• optimum charge = external cost – green taxes and subsidies
• use of such taxes around the world – laws and regulations
•
Policy alternatives
– charging for use of the environment
• emissions charges • user charges
• optimum charge = external cost
– green taxes and subsidies
• use of such taxes around the world
The Environment: a Case Study
The Environment: a Case Study
•
Policy alternatives
– charging for use of the environment • emissions charges
• user charges
• optimum charge = external cost – green taxes and subsidies
• use of such taxes around the world – laws and regulations
• advantages and disadvantages
•
Policy alternatives
– charging for use of the environment
• emissions charges • user charges
• optimum charge = external cost
– green taxes and subsidies
• use of such taxes around the world
– laws and regulations
The Environment: a Case Study
The Environment: a Case Study
•
Policy alternatives
– charging for use of the environment • emissions charges
• user charges
• optimum charge = external cost – green taxes and subsidies
• use of such taxes around the world – laws and regulations
• advantages and disadvantages – education
•
Policy alternatives
– charging for use of the environment
• emissions charges • user charges
• optimum charge = external cost
– green taxes and subsidies
• use of such taxes around the world
– laws and regulations
• advantages and disadvantages
The Environment: a Case Study
The Environment: a Case Study
•
Policy alternatives
– charging for use of the environment • emissions charges
• user charges
• optimum charge = external cost – green taxes and subsidies
• use of such taxes around the world – laws and regulations
• advantages and disadvantages – education
– tradable permits
•
Policy alternatives
– charging for use of the environment
• emissions charges • user charges
• optimum charge = external cost
– green taxes and subsidies
• use of such taxes around the world
– laws and regulations
• advantages and disadvantages
– education
The Environment: a Case Study
The Environment: a Case Study
•
Policy alternatives
– charging for use of the environment • emissions charges
• user charges
• optimum charge = external cost – green taxes and subsidies
• use of such taxes around the world – laws and regulations
• advantages and disadvantages – education
– tradable permits
• advantages and disadvantages
•
Policy alternatives
– charging for use of the environment
• emissions charges • user charges
• optimum charge = external cost
– green taxes and subsidies
• use of such taxes around the world
– laws and regulations
• advantages and disadvantages
– education
– tradable permits
The Environment: a Case Study
The Environment: a Case Study
•
How much can we rely on governments?
– governments must have the will to protect the environment
• depends on attitudes of various interest groups
– must be able to identify problems and appropriates solutions
– when problems are global:
• may require international agreements
• governments are likely to be more concerned with their own national interests
•
How much can we rely on governments?
– governments must have the will to protect the environment
• depends on attitudes of various interest groups
– must be able to identify problems and appropriates solutions
– when problems are global:
• may require international agreements
