Market failure and government intervention
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A level economic revision webinar covering aspects of market failure and government intervention
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Market failure and government intervention
- 2. MARKET FAILURES IN FOCUS MARKET FAILURE & INTERVENTION Labour market Financial Markets Environmental Market Failure Product Markets Housing Market Commodities Markets
- 3. KEY MARKET FAILURE CONCEPTS TO REVISE MARKET FAILURE & INTERVENTION • Economic welfare outcomes • Self-interested behaviour • Rational behaviour • Consumer and producer surplus • Private benefit and private cost • Social welfare outcomes • Social benefit and social cost • Economic efficiency • Allocative • Productive (including economies of scale) • Dynamic
- 4. COMPLETE AND PARTIAL MARKET FAILURE Complete Failure: Pure Public Goods Partial Failure: Negative externalities from production MARKET FAILURE & INTERVENTION
- 5. PUBLIC GOODS Sanitation infrastructure Flood defence projects Crime control for a community Reduced risk of disease from vaccinations Freely available knowledge e.g. online learning Public service broadcasting MARKET FAILURE & INTERVENTION
- 6. NEGATIVE EXTERNALITIES FROM PRODUCTION Air pollution from factories Pollution from fertilizers Industrial waste Noise pollution Collapsing fish stocks Methane emissions MARKET FAILURE & INTERVENTION
- 7. NEGATIVE EXTERNALITIES FROM PRODUCTION Marginal Private Cost (MPC)P1 Q1 Marginal Private Benefit (MPB) Costs, Benefits £s Marginal Social Cost (MSC) Q2 P2 The equilibrium output delivered by a free market is at Q1 where MPB = MPC and it is allocatively inefficient. We assume here that there are no externalities from consumption, therefore MSB=MPB Note If MSC pivots away from MPC then the marginal external cost of extra output is increasing Output/Quantity MARKET FAILURE & INTERVENTION Diagrams should be ACE! That means remember to label the Axes, Curves and all Equilibrium points
- 8. NEGATIVE EXTERNALITIES FROM CONSUMPTION Particulates from vehicle pollution Household waste Noise pollution from neighbours Air pollution from smokers Traffic congestion Impact of addiction on families Litter from tourists Spillover costs from rising levels of obesity MARKET FAILURE & INTERVENTION
- 9. NEGATIVE EXTERNALITIES FROM CONSUMPTION (AQA) MARKET FAILURE & INTERVENTION MSB MPB MPC = MSC Benefit, Cost Quantity consumedQ1 Q2 Deadweight loss of social welfare = ABC A C B Social optimum is where MSB = MSC With negative consumption externalities, if consumption of a product reduces benefits enjoyed by third parties, the benefits to society are less than benefits obtained by individuals consuming the product. Negative externalities lead to overconsumption and hence overproduction Remember your ABC’s with diagrams – Accurate, Big and Clear
- 10. POSITIVE EXTERNALITIES FROM CONSUMPTION Health programmes e.g. HNS services Early years education e.g. nursery provision Subsidised Bike Schemes in urban areas Public libraries / community spaces Museums and Galleries Free school meals / nutritional advice MARKET FAILURE & INTERVENTION
- 11. POSITIVE EXTERNALITIES FROM CONSUMPTION Costs, Benefits £s Output/Quantity Marginal Private Cost P1 Q1 Marginal Private Benefit Marginal Social Benefit P2 Q2 If the market price ignores positive externalities, then there will be under- consumption Social optimum position is output Q2 whereas the market equilibrium is Q1 This is the area of social welfare loss because the market output Q1 is lower than the socially efficient level MARKET FAILURE & INTERVENTION
- 12. POSITIVE EXTERNALITIES FROM PRODUCTION MARKET FAILURE & INTERVENTION Open Source Software made freely available to users Positive spillover effects from research and development
- 13. POSITIVE EXTERNALITIES FROM PRODUCTION (AQA) MARKET FAILURE & INTERVENTION MPB MPC Benefit, Cost Quantity producedQ2 Q1 A C B MSC Deadweight loss of social welfare Social optimum is where MSB = MSC Because there are positive externalities in production, the marginal social cost of production is less than the marginal private cost of production. A good example arises from universities making their research available as a public good. Positive production externalities shifts the supply curve to the right.
- 14. MARKET FAILURE AND NET SOCIAL WELFARE LOSS MPB MSC Benefit, Cost Q2 Q1 B A MPC MSB Social optimum is where MSB = MSC There are net social costs in this market) i.e. it is costing society more to produce these units than society is valuing these units. As a result, the social optimum output is lower than the free market equilibrium output. A: Where MPB=MPC B: Where MSB = MSC Output/Quantity MARKET FAILURE & INTERVENTION
- 15. MARKET FAILURE AND NET SOCIAL WELFARE BENEFITS MPB MSC Benefit, Cost Q1 Q2 B A MPC MSB Social optimum is where MSB = MSC In this example, there are net social benefits from producing and consuming the product. This is because there are substantial external benefits from consumption. The free market mechanism might under-provide this product again leading to market failure.A: Where MPB=MPC B: Where MSB = MSC Output/Quantity MARKET FAILURE & INTERVENTION
- 16. MERIT GOODS MARKET FAILURE & INTERVENTION Costs, Benefits £s Output / quantity MPC P1 Q1 MPB MSB P2 Q2 One cause of under- consumption and therefore market failure is that people will only consider their own private costs and benefits – leading to a private optimum output of Q1. If the consumption of merit goods leads to external benefits, the optimum output from society’s point of view is higher at Q2. The under- consumption of a merit good is a cause of market failure. P3 Welfare loss arising from under-consumption Merit goods give rise to external benefits
- 17. DE-MERIT GOODS MARKET FAILURE & INTERVENTION High Caffeine Energy Drinks High-fat, high- sugar & high-salt foods Violent films and games Hands-free mobile phones in vehicles Alcohol fraud and binge drinking Tobacco products
- 18. INFORMATION GAPS – OVER-ESTIMATING BENEFITS Costs, Benefits £s MPC P1 Q1 MPB (fuller information) P2 Q2 Individuals may have imperfect information about their own private benefits. If they had better/fuller information on the benefits to themselves of consuming a good or service, the marginal private benefit curve would shift lower leading to a smaller equilibrium quantity MPB (limited information) Market demand would be lower if consumers had fuller information Output/Quantity INDIVIDUAL DECISION MAKING Simply drawing a diagram from memory will likely only allow you to gain AO1 marks. To be able to access higher-skill marks, you will need to make a change or adapt your diagram – perhaps shift a curve, indicate a particular important area and so on.
- 19. INFORMATION GAPS Risks from using tanning salons Addiction to painkillers & other drugs How to gain entry to elite university courses Complexity of personal pension schemes Uncertain quality in buying second hand products Knowledge of the nutritional content of foods Cowboy builders or other “rip-off merchants” Tourist bazaars or buying and selling antiques INDIVIDUAL DECISION MAKING
- 20. PURPOSE OF GOVERNMENT INTERVENTION Taxes & Subsidies Maximum & Minimum Prices Regulating the Market State Ownership / State Funding & Provision Government intervention MARKET FAILURE & INTERVENTION
- 21. TOPICAL EXAMPLES OF GOVERNMENT INTERVENTION MARKET FAILURE & INTERVENTION Minimum alcohol pricing Capping pay day loan interest rates 2018 UK Sugar Levy Maximum single bets on FOBTs Minimum price for carbon emissions Strict C02 emissions limits for vehicles Proposed plastic straw, stirrer bans Apprenticeship Levy for firms
- 22. REGULATIONS TO CORRECT FOR EXTERNALITIES Smoking bans Minimum age laws Maximum C02 emissions for vehicles Recycling directives Ban on diesel cars in the UK (2040) Fishing quotas MARKET FAILURE & INTERVENTION Regulation is a non-market based approach to addressing market failures
- 23. REGULATIONS TO CORRECT FOR EXTERNALITIES Case for regulating activities causing negative externalities Costs / disadvantages of adding extra regulation of industries • Regulation acts as a spur for business innovation e.g. to cut the level of carbon emissions • High cost of enforcement and weak penalties might make regulations ineffective • Regulation may be more effective if demand is unresponsive to price changes • Regulations can lead to unintended consequences a cause of government failure • Regulations can be gradually toughened each year – this will stimulate capital investment e.g. C02 emissions from vehicles • The cost of regulations can discourage small businesses and therefore lead to less competition in markets MARKET FAILURE & INTERVENTION
- 24. GOVERNMENT FAILURE Political self interest / influence of political lobbying Policy myopia – i.e. the search for “quick fixes” Regulatory capture – regulators operating in interests of producers Information failures & failure to rigorously test a policy Disincentive effects affecting both consumers and producers High Enforcement / Compliance Costs of an intervention Conflicting Policy Objectives e.g. environment and economic growth Damaging effects of regulatory “red tape” on business competitiveness MARKET FAILURE & INTERVENTION
- 25. EVALUATING GOVERNMENT INTERVENTION IN MARKETS MARKET FAILURE & INTERVENTION • How significant is the market failure? (consequences) • Can the market / price mechanism find some solutions? • What are the likely consequences of not intervening? • How effective is an intervention? (i.e. consider alternatives) • Who are the winners / losers from an intervention? • Consider potential for one or more government failures • Which works best in the long run? – market-based or regulatory (“command and control”) approaches? • What impact might behavioural interventions have? (e.g. nudges such as changing defaults, choice architecture)