Market Failure Public Goods Externalities Merit & Demerit Goods Imperfect Information Factor Immobility Market Dominance
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How the market failed Goernment Goernment Interention ! Policies ! Poli Policy cy effe effect cti ien enes esss ! "imitations Goernment Goernment Failure
Public Goods Defnition: Goods that are 1) non-rival in consumption and 2) non-excludable Eg. Street lighting, national defense, warning systems
Non-rialrous !onsum"tion of a good#serice by an indiidual consumer does not reduce the $ty of the good aailable to other consumers Eg. Street lighting is non-rial in consum"tion as each additional "edestrian does not reduce the amount of light emitted by the street lam"s. Non-e%cludable Goods that are non-e%cludable are goods that are either im"ossible or "rohibitiely costly to e%clude non-"ayers from consuming the good. Eg. &sunami warning systems in a coastal town im"ossible to only inform ""l who hae "aid for the serice and not inform those who did not "ay. 'ow mkt failed free rider "rob no "rice signals Since no one can be e%cluded from the consum"tion of the "ublic good, consumers would not be willing to "ay for such a good. Since "ublic goods are non-rialrous in consum"tion does not get used u" bcos more ""l use it ability to free ride "ersists into the () no one will "ay for the good ultimately good won*t be "roduced. Failure of "rice mechanism, failure of "rice signals to direct any resources to the "roduction of the g ood. Price signal sent by consumers + , but it does not mean that consumers do not want the good to be "roduced. •
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Got. interention irect "roision y haing got. to "roduce these goods, the decision to "urchase these goods is now taken out of the hands of the indiidual consumers but into the collectie hands of the goernment. Financed by com"ulsory ta%es, so indiiduals end u" "aying for the good in the end. /Not all goods that are "roided by the state + "ublic goods0 (imitations 1hile the goernment can "roduce a "ublic good that would otherwise in a free mkt not be "roduced, some goods with "ublic goods characteristics may not be alued su2ciently to be "roduced in the free market in the 3rst "lace, een if they had not been "ublic goods. irect "roision might lead to the "roduction of a good which should neer ! hae been "roduced in the 3rst "lace, drawing scarce resources away from "roducing goods that ""l actually alue more, leading to allocatie ine2ciency. No net bene3ts to society from the "roduction of that good. Eg. 4im 5ong-6n statue ! 7mt. of "ublic goods to be "roduced 87llocatie ine2ciency9 :er#under-"roduction of t he good ! irect "roision does not necessarily result in an e2cient allocation of ! resources, only a greater likelihood of a more e2cient allocation of resources than in a free mkt. (eads to got. failure, Eg. N orth 4orea e%cessiely s"ending on national ! defense. Productie ine2ciency irect "roision inoles state-owned 3rms "roducing the good ! 7s with most state-owned 3rms, "ro3t ma%imising aim is absent "oor ! cost management "roductie ine2ciency at 3rm*s leel. 7bsence of com"etition dynamic ine2ciency ! Solutions Goernment should reiew its decisions on "roducing "ublic goods on a regular basis, im"ose strict checks on state owned 3rms in terms of cost management, and build into the system the incentie to continuously innoate to foster • •
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greater dynamic e2ciency.
E%ternalities; 8a9 Positie E%ternalities Defnition: Positive externalities reer to the benefts enjoyed by third parties rom the consumption or production o a ood! "! "ducation# healthcare
Price SS + MP! + MS!
ME
SS + MP! + Subsi dy +
SS* +
7
MS
MS
Fig. AB Positie e%ternality
?"
?s
+ MP ?ty
Gra"h e%"lanation MS < MP by a di=erence e$ual to ME ue to the e%istence of the "ositie e%ternality, the mkt results in under-consum"tion of the good allocatie ine2ciency 7ssuming no >e e%ternalities, mkt ss cure + MP! + MS! Social e$m is at ?s, where MS + MS!, but "riate e$m is at ?", where MP + MP!. tw ?s and ?", as MS < MS!, a 1( of area 7 is generated. &he loss in "otential welfare can be recoered if o#" were raised from ?" to ?s. Since ?" @ ?s, the good is under-"roduced#under-consumed. • •
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+ MP
Fig. CB Subsidy
? ?s + " Policies to manage "ositie e%ternalities Subsidies raise consum"tion#"roduction of good for a more socially desirable outcome Giing "roducers a "er unit subsidy e$ual to ME lowers "roduction cost and shifts the MP! down to MP!*. New "riate e$m o#" of ?"* now coincides with social e$m o#" of ?s allocatie e2ciency achieed as o#" is raised to the socially o"timal leel. •
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Free Proision is socially o"timal
Free Proision is not socially o"timal
!osts,
!osts,
MS SS + MP! + MS!
+ MP SS* + MP!*
?t y ?" + ?f de"ends on the ?t free "roision is socially ?s e2cient Fig. AB 1hether Free "roision is y e%tent of the e%ternalities. Dn Fig. A, the "ositie e%ternalities generated is ery large such that MS lies ery far aboe MP. Social outcome where MS + MS! is at ?s. &o achiee ?s, o#" needs to be subsidised to the e%tent where MP! shifts to MP!* such that the "riate e$m where MP + MP!* occurs at o#" ?s. Since ?s is the "oint where the cure cuts the horiontal a%is, the e=ectie "rice of the good is now ero, i.e. the good has been subsidised to the "oint where the entire cost of "roducing the good is borne by the goernment, which means that the good is free. •
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