Market Failures

Frederick University

2014

Main Economic problems

Questions What and how

much

How

For Whom

Problems Efficiency in

allocation Efficiency in

motivation Efficiency in

distribution

Market Functions

Achieve: Efficiency in allocation Efficiency in motivation Efficiency in distribution

Market failures

Market failures are all cases when markets fail to perform their

functions - functional market failures, or

markets perform their functions, but the outcomes do not fit the system of social values

- social market failures

Public goods I won’t use it andI am not gonna pay for it!

Public Goods – goods, which are nonrival and nonexcludable in consumption

Externalities

A chemical companywould like to build a plant here

What about our rivers?

We’ll make them any color

you want

Externalities

Externalities – cases where social costs and benefits differ from private costs and benefits

P

Q

D

S – private cost

q1

p1

Social cost

qs

ps

Merit goods Merit goods – goods,

whose utility consumers tend to underestimate

P

Q

D

S

q1

P1

subsidy

q2

p2

P3

Demerit goods

Demerit goods – goods whose utility consumers tend to overestimate

P

Q

D

Stax

q1

p1

q2

p2

Asymmetric Information

Racing? Let me justget my car insurance!!!

Incomplete Markets

Bounded rationality Moral hazard and adverse

selection

Monopoly vs. Pure Monopoly

Monopoly – an ability to produce a good or a service that others are not able or allowed to.

Pure monopoly – a market structure, determined by only one producer of a good with no close substitutes

Natural Monopoly Natural monopoly – a monopoly

position, determined by factors, which cannot be replicated

Types of natural monopoly: Monopoly, created by a possession of

resources, inaccessible to competitors Monopoly, justified by economies of

scale Local monopoly

Economies of Scale

P

Q

AC

AC

Institutional Monopoly Institutional monopoly – a monopoly,

deliberately created by economic decision makers

Types of institutional monopoly: Monopoly, created by a collusion, or a

merger Monopoly, created by institutional

barriers to entry to the industry Government monopoly

Instability

Unstable macroeconomic equilibrium, creating cyclical fluctuations in employment and price level

The Role of Government

Musgrave’s Three Branches stabilization allocation distribution

The government failureOf course you may registera complaint about all the government paperwork, sir, ...But it has to be in writing.