Market failure

For basic understanding of market failure.

1. MARKET FAILURE And Its DIAGNOSIS

2. MARKET FAILURE CAN OCCUR IN NO.OF WAYS – Some products can 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 over, these social cost are not included in their market price. Market Failure implies a loss of allocative efficiency. The potential total surplus in the market is not maximized. A dead weight loss may exists.

3. 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

4. Reason of Market Failure - 1. Lack of or weak property rights Property is an asset that is either tangible( water, land) or intangible( patent, copyrights). The govt.estaliblishes property rights to ensure protection of assets and thus provide the foundation of a capitalists/market based society. The owner of property have rights which means they can – use property in a way so that it doesn't diminishes the well being of others. Derive an income from using property like lease, rent. Sell, dispose off or sale the property. If there are no property rights on resources, consumers or producers will exploit them and sometimes generate a negative externality. Eg - air pollution, water pollution. Property rights can reduce negative externalities of production. eg – no property rights – over fishing, free fishing, fish stocks declining. with property rights – fishing quota purchased, allotted to fishing companies.

5. Property rights regime and 3 different types -

6. 2. Public goods – Private and pure public goods Private goods Public goods They are exclusive, transferable, enforceable They are non-exclusive ,non transferable,enforceable -non Rival in consumption Non- rival in consumption They have positive marginal cost They have zero marginal cost. Ex – owning a car, house as you have rights to your property. Ex- like national defense, biodiversity, clean air. People may have option of consuming it or not. People do not have an option of not consuming

7. Open access and common property goods Open access Common property Rival in consumption Rival in consumption Non exclusive, non transferable, even when ownership rights exists. They are exclusive for group of people. Rights or us may be transferable by individual or group. Non – enforceable There may not be legal title to ownership but group may be able to enforce their ownership rights by means of social sanction. Ex- ocean fisheries and migratory wildlife. Ex- common grazing land

8. Semi public goods Non rival in consumption Zero marginal cost of provision Non exclusive although ownership rights exists. Even though the owner of service provider cannot exclude others from consumption, consumers can choose not to cosnume . Ex- radio and TV broadcast In this case the signal strength does not depend on no. of consumers ( i.e.zero MC) Consumers cannot be excluded but they may choose not to receive signals by turning it off.

9. Congestion goods The are exclusive Can be either rival or non- rival in consumption. They may exhibit the characteristics of private goods and public goods at different level of consumption. Ex- campsite, roads, bridges, fishing, historic sites. At level ob certain no. of people can enjoy amenities without reducing other people enjoyment. Here MC=0.therefore public goods. After b congestion sets and MC = +ve. After c,the MC = infinity. As congestion reaches max. Cost quantity mc b c

10. 3.Externalities An externality is an effect that is ‘external’ to the causing agent. That is the person causes an effect that impacts on other people. An externality is said to exists when the utility of an economic agent is affected by the actions of another. An externality is often Negative. This occurs when the affected person suffers a loss in utility that is uncompensated. An externality can also be Positive. This occurs when effect is beneficial to the affected person. Example – Negative – air, water and noise pollution. Positive – where one firms technological breakthrough benefits the other firms in industry thiugh not contributed in research.

11. A Negative Externality Example If there are no externalities, P Q is the equilibrium If there are externalities, the marginal social cost differs from the marginal private cost, and P is too low and Q is too high to maximize social welfare

12. A Positive Externality Example If there are no externalities, P Q is the equilibrium If there are externalities, the marginal social benefit differs from the marginal private benefit, and both P and Q are too low to maximize social welfare

13. Classification of externalities - Relevant externality A n externality is not relevant so long as affected person is indifferent to it. It becomes relevant when affected person is made worse-off by activity and wants offending person to reduce the level of it. Ex- chicken farm in backyard interferes with satisfaction you derive then it’s a relevant externality but if high decibel music does not bother you then its not relevant. Pareto relevant externality Externality exists when its removal results in a pareto -improvement. It is a situation where its possible to take action such that affected person is made better-off without making the offending person worse- off. When level of externality is optimal, it becomes pareto irrelevant. Ex – telephone company erects tall tower near forest but it reduces the scenic value of forest. A pareto relevant externality exists because it is possible for telephone company to color that would blend with foliage.

14. Static and dynamic It can be explained with help of example. 2 fishers who are operating under and open access or property rights regime. A static externality is when one creates an externality for other by overfishing. A dynamic externality if offending party is harvesting fish that nay have some future value. like a juvenile fish species. Pecuniary externality The form which is transmitted through the price system. Externality is an ‘un-priced’ effect. When the externality is transmitted through higher-price or reduced cost. Ex- large business move into residential, therefore rentals go high. Thus creating a negative externality. when manufacturer benefits as result of a supplier reducing cost of product.

15. 4. Types of market structure Market power monopoly Inefficiencies Higher prices 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 . P1 P0 Q1 Q0 E0 E1

16. Failure by market structure Due to no.of buyers and seller. Entry barriers (licensing, syndicate etc.) Natural monopoly or market power Market may also fail because – Market dominance by monopolies can lead to under-production and higher prices than would exist under conditions of competition . Factor immobility causes unemployment hence productive inefficiency

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

18. Role of government in diagnosis of market failure Roles of the Government : Regulatory role Allocative role Distributive role Stabilization role

19. 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 the products and services . 

20. Allocative Role The government must determine how some resources are allocated. Collective goods such as roads, education and health. Distributive Role The free market outcome results in an unfair distribution of income, so the will intervene to assure everyone has a sufficient income. They do this through benefits, state housing and educational courses. Stabilization Role The government intervenes in the market to ensure there is steady growth. They do this through monetary and fiscal policy.

21. Methods of Dealing with Externalities Direct regulation is when the government directly limits the amount of a good people are allowed to use Incentive policies Tax incentives are programs using a tax to create incentives for individuals to structure their activities in a way that is consistent with the desired ends Market incentives are plans requiring market participants to certify that they have reduced total consumption by a certain amount Voluntary solutions

22. Correcting Market Failure • Firms don’t pay the External cost, as they are not affected by the pollution. • According to Pigou , if a tax = External cost is imposed (Tax = EF), then the externality can be internalised . • Called Pigovian tax. • Therefore if External cost is internalised , then new equilibrium will be at G, and Q will fall. • Pollution levels or social costs will fall.

23. How to internalize external costs • Pigovian taxes : • Tax the polluter or the creator of the externality. Such as: Green taxes on carbon dioxide releases, or on effluents from factories, – Raising the prices of more polluting or more environmentally damaging goods, – Making polluters bear the cost of controlling or mitigating their pollution.

24. Pigovian Subsidies : • Reward by lowering the price and cost of environmentally safe products, and techniques. – Green products, – Alternative renewable energy, – Bio degradable plastics, • These measures will send market signals to reduce environmentally unsafe activities, and encourage environmentally friendly ones.

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