Market Failures and Government Intervention
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Introduction to Public Fiscal Administration
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Market Failures and Government Intervention
- 1. Introduction on Public Fiscal Administration Christopher R. Abne MARKET FAILURE AND FUNCTION OF GOVERNMENT
- 2. Market Failure Sources of Market Failure Types of Market Failure Government’s Response to Market Failure
- 4. Market failure refers to the set of conditions under which a market economy fails to allocate resources efficiently. But, due to various reasons when market mechanism is unable to make fair play or interaction of demand and supply, that is the situation of market failure.
- 5. At times when markets fail to: Allocate resources efficiently. Provides goods beneficial to society. Stop production and consumption of harmful goods.
- 6. Market Failure can occurin a numberof ways: Some products may be underproduced ornot at all. Some good may be overproduced. The production orconsumption of some products affects third parties.
- 7. Market Failure Examples: Pollution, air, water, soil Traffic congestion Deforestation and loss of biodiversity Health problems associated with consumption of tobacco, alcohol and illicit drugs Depleted fish stocks Global Warming
- 9. Sources of the market failure: Market imperfections Public Goods Externalities Inequalities
- 10. Market imperfections Market Power/Monopoly Inefficiencies Higherprices Incomplete Information Imperfect knowledge of the market can also cause market failure The lack of fully informed decision making might lead to the market failure.
- 11. P1 P0 Q1 Q0 E0 E1 Market imperfections and Market failure
- 12. Public Goods
- 13. Private Goods i. Rival ii. Depletable iii. Excludable Public Goods i. Non – Rival ii. Non – Depletable iii. Non – Excludable iv. Zero Marginal Cost Types of Goods:
- 14. Public Goods Public goods includes the services that are provided by the government. Pure public goods have the following characteristics: Non excludability – everyone can consume the goods whetherthey pay ornot. Non rivalry in consumption – consumption by one person doesn’t reduce consumption forothers. Examples: streetlighting, nationaldefence
- 15. Public Goods and Market Failure An individual can’t pay forpublic goods as others can get the benefits fromconsumption without paying which is the failure of market mechanism. Private companies will not supply public goods as they don’t make an economic profit on them. Thus, public goods are only supplied by the government and financed through taxation.
- 16. Externalities
- 17. Externalities A consequenceof an economic activitiesthat are experienced by unrelated third parties. Factorswhosebenefits (external economies) and costs (external diseconomies) arenot reflected in themarket price of goodsand services. Externalitiesarea loss or gain in the welfare of one party resulting from an activity of another party, without being any compensation for thelosing party.
- 18. Externalities (co n’ t) Externalitiesresult from differencesbetween privateand social costsor benefits Externalitiescan bepositiveor negative: Positive– 3rd partiesbenefit from theproduction and/or consumption of goodsand services. Negative– 3rd partiesbear spill over cost from the production and/or consumption of goodsand services.
- 19. Negative externalities Negativeexternalities mean that social costs(haveto compensate) arehigher so thenew supply curveshould beS1 and equilibrium moved to P1.
- 20. External Costs /Negative externalities External costscreated by businessescan impact the environment in thefollowing ways: Urban blight – excessivedevelopment and inappropriatedevelopmentsmean theenvironment is visually lessattractive, lossof farmland Production and disposal of waste – thiscould includean increasein litter and rubbish from packaging
- 21. External Costs /Negative externalities Use of energy – absorb thefacilitiesof future generation if peopledon’t adopt thesustainable energy plan. Pollution Noise– from cars, lorries, factoriesetc. Air – emissionsfrom carsand delivery vehicles Land, Sea, Water
- 22. Positive Externalities If the business was supplying products ignoring social benefits (they get advantage) so that the initial supply curve S1 shift to S.
- 23. External Benefits / Positive externalities Externalbenefitsareadvantagesabusinessbringsto the local community when it locatesitsbusinessin aparticular area. Thesebenefitswill bepositivefor thelocal community. Examples: • Emplo yment • Quality o f life • Pro viding a service • Regeneratio n o f land
- 24. Externalities and Market failure Externalities can lead to market failureif thepricing mechanism failsto account for thesocial costs and benefitsof production.
- 25. Inequalities
- 26. Inequalities In market economies, an individual’sability to consume goodsand servicesisdependent on their income/wealth. An unevendistributionof income/wealthwithin an economy can result in an unsatisfactory allocation of resourcesand thereforemarket failureprevail. In many developing countries, incomeinequalityis great thereforeresulting in misallocation of resources.
- 27. In Summary Market imperfections can be caused by monopolies, imperfect market knowledge and factorimmobility which can result in misallocation of resources. Public goods are goods that are provided by the government e.g. street lighting.
- 28. Externalities are caused because of social benefits/costs . Positiveexternalities occurwhere social benefits are greaterthan private benefits Negativeexternalities occurwhere social costs are greaterthan private costs Inequalities in wealth and income distribution may result in a misallocation of resources as the rich consume more.
- 30. Failure by the market structure o Dueto number of buyersand sellers o Entry barriers(syndicate, licensing, etc) o Natural monopoly or market power (There is also equalchances o f pro viding the go o ds and services at the co mpetitive rates so that go vernment interventio n is necessary) Failure by incentives oDueto externalities– differencein social and private costs& benefits Types of market failure
- 32. The Government Ro les o f the Go vernment: Regulatory role Allocative role Distributive role Stabilisation role
- 33. Regulatory Role Regulatory response to structure failure i. Control over industry structure – by antitrust policies, for instance, telecom industry, diary industry, etc ii.Direct control – by fixing the quantity and price of theproductsand services.
- 34. Regulatory response to incentive failure
- 35. Patent It is the special right grant to the producers to use or sale any invention to any firm for the specific period. The main objective is to promote the invention and innovation. Arguments on patent system For Important incentives Necessary incentives Invention disclosed Against Less use Ineffective perversion
- 36. Subsidy The government also respond to the market failure by providing subsidies to the private business firm. It may be two types: Direct subsidy like: Special tax treatment (ITC), Direct payment etc Indirect Subsidy like : Construction of road, Providing of Maintenance cost etc
- 37. Granting the operating rights Incentives given to the regulated firms to provide services in the public interest. It is the grant provided by the government to the firm to operate. For instance, license of media, banks, educational institutions, etc
- 38. Operating control The control impose by the government in order to limit the activities of the business firm. a.Control on environment pollution b.Control on food products c.Price control d.Industrial work condition/Quality of Work Life e.Protection of minority groups
- 39. Tax policy The tax policies are like as negative subsidies to limit the unwanted activities in the market. For instance, environmental taxes for emission whereas ITC for pollution control devices, etc.
- 40. Allocative Role Thegovernment must determinehow someresourcesareallocated. Collectivegoodssuch asroads, education and health.
- 41. Distributive Role Thefreemarket outcomeresultsin an unfair distribution of income, so thewill interveneto assureeveryonehasasufficient income. They do thisthrough benefits, state housing and educational courses.
- 42. Stabilisation Role The government intervenes in the market to ensure there is steady growth. They do this through monetary and fiscal policy.
- 43. Government Intervention Taxes – acompulsory payment to the government. Subsidy– apayment by government to firmsto keep costslow. Transferpayments – apayment madeby thegovernment with nothing in return.
- 44. THANK YOU.
Editor's Notes
- In the free economy, the free play of demand and supply determines the price, the resources are used efficiently to provide private goods. Consumers show their preferences toward certain goods, producers try to produce goods and services at least cost possible and competition ensures availability of output as per the needs of consumers. But due to various reasons when above market mechanism fails to take place it’s called the market failure. Thus, market failure covers all the circumstances in which equilibrium in free unregulated market fails to achieve efficient allocation.
- Some products may be under produced or not at all. Thus resources are under allocated to their production. Some good may be over produced. Thus resources are over allocated to their production. The production or consumption of some products affects third parties with spill overs, these social costs are not included in the private market price. Market failure implies a loss of allocative efficiency the potential total surplus in the market is not maximised. A deadweight loss may exist.
- Market Power/Monopoly This is often viewed as allocating resources inefficiently, as the producer is able to charge higher prices due to being the only producer in the market. In case of monopoly market, the monopoly houses may supply goods which have high profit margins but may less supply the goods which have high demand but low margin, hence market failure take place. Incomplete Information For example: consultancy – only provide the benefits but hide the drawbacks, information regarding the highly sophisticated products in which consumers/investors may not process them correctly – technology products, wages, rents, excess/low production due to incorrect forecasting, etc Perfect Information All consumers are well informed enabling them to make sensible decisions.
- Types of Goods: Private Goods Rival: one person consuming the good excludes other people from using the same good. Depletable: Once one person has used the good, the availability of the good decreases Excludable: a person who is not willing to purchase the good can be excluded from consuming it. Public Goods Non rival: many people can enjoy consuming the good and others are not excluded. Non-depletable: once one person has consumed the good, there is just as much still available as prior. Non – excludable: once the good is provided by the market there is no practical way of excluding others from consuming the good. Zero Marginal Cost
- Principle of exclusion- Who pay should get the benefits, who doesn’t pay should not get the benefits.
- Externalities is about goods that incur costs or benefits to others. The market won’t take account of the cost and benefit to others so if externalities are present the market is not allocative efficient.
- If perfectly competitive markets are left on their own they may fail to provide an efficient and fair allocation of resources so the government steps in.
- The rules that are established to make the market system work effectively. Employment Relations Act, Fair Trade Act and the Consumer Guarantees Act.