MARKET FAILURE
In the real world, market fails to achieve social efficiency.
SOURCES OF MARKET FAILURE:
Existence of Market Power (Imperfect Competition)
Existence of Externalities
Existence of Public & Merit Goods
Existence of Market Power
Recall: Social efficiency MSB = MSC
Market power => __________(Imperfect Competition)
=> ___________________
Existence of Market Power
Example: Monopoly
$ MC = MSC
AR (P)=MSB
Q1 Q2
P1MSB=MSC
MC1MR
Eqm: MR = MCPC: MR = AR = MSB MC = MSC=> MSB = MSCat o/p = Q2
Monopoly: price = P1, o/p = Q1=> P1 > MC1=> MSB > MSC=> social inefficiencyQty
fig
MRO
$
Q
Ppc
Qpc
AR = D
a
Qm
Pm
b
Consumersurplus
Producersurplus
Deadweightwelfare loss
MC
Welfare Loss under monopoly
c
Existence of Externalities
Externalities
_____________________ to society, over & above those experienced by the individual producer & consumer
Drive a ____________________- between MSC & MPC- between MSB & MPB
MSC = MPC + _____ MSB = MPB + _____
Existence of Externalities
Two types of externalities:
The effects of a decision by consumers and producers that has an impact on a third party Positive Externalities – _______________ on
third parties
Negative Externalities – _____________ by third parties
Existence of ExternalitiesCosts and benefits in production:
External costs in production – ____________e.g. air and water pollution, congestion, noise,
pollution
External benefits in production – __________e.g. human resource development, research
and development in industry
Existence of Externalities
Costs and benefits in consumption:
External costs in consumption – ____________e.g. passive smoking, litter, noise
External benefits in consumption – __________ e.g. preventative health care – vaccinations,
public transport, attractive gardens, bathing regularly!
Existence of Externalities
Our Focus:
Case a: Negative Externality:External costs in production – MSC > MPC
Case b: Positive ExternalityExternal Benefits of Consumption - MSB > MPB
Negative ExternalityCase a: External Costs of Production
Example: Pollution -> MSC > MPC [ MSC = MPC + MEC ]
Socially optimumo/p = Q2where P = MSCHowever, firm produces at Q1=> _____________
QUANTITY
DD (MPB = MSB)
SS (MPC)
Q1
P1
Q2
P2
MSC
MEC
$
Positive Externality
Case b: External Benefits of Consumption Eg: Public Transport -> MSB > MPB [ MSB = MPB + MEB ]
Socially optimumo/p = Q1where P = MSBHowever, consumption level at Q2=> __________________
QUANTITY
DD (MPB)
(MSC = MPC) SS
Q2
P2
MSB
MEB
Q1
P1
$
Mindmap of Externalities