Market Failure

Market Failure

Failure of the market to achieve allocative efficiency,

resulting in an over allocation of resources (over provision
of a good) or an under allocation of resources (under
provision of a good).
Market Failure
• Social Efficiency = where external costs and
benefits are accounted for
• Allocative Efficiency = where society produces
goods and services at minimum cost that are
wanted by consumers
• Technical Efficiency = production of goods and
services using the minimum amount of resources
• Productive Efficiency = production of goods and
services at lowest factor cost
Market Failure
• Allocative efficiency:
• Also referred to as
• Pareto Efficient Allocation – resources cannot be readjusted
to make one consumer better off without making another
worse off – zero opportunity cost!
• After Vilfredo Pareto (1848–1923)
Market Failure
• 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
Market Failure
• Imperfect Knowledge:
• Consumers do not have adequate technical knowledge
• Advertising can mislead or mis-inform
• Producers unaware of all opportunities
• Producers cannot accurately measure productivity
• Decisions often based on past experience rather than
future knowledge
Market Failure
• Goods/Services are
differentiated
• Branding
• Designer labels - they cost
three times as much but are
they three times the
quality?
• Technology – lack of
understanding of the impact
• Labelling and product
information
Market Failure
• Resource Immobility
• Factors are not fully mobile
• Labour immobility – geographical and occupational
• Capital immobility – what else can we use the Channel Tunnel
for?
• Land – cannot be moved to where it might be needed, e.g.
London and South East!
Market Failure
• Market Power:
• Existence of monopolies and oligopolies
• Collusion
• Price fixing
• Abnormal profits
• Rigging of markets
• Barriers to entry
Market Failure
• Inadequate Provision:
• Merit Goods and Public Goods
• Merit Goods – Could be provided by the market but consumers
may not be able to afford or feel the need to purchase – market
would not provide them in the quantities society needs
• Sports facilities?
Market Failure
• Merit Goods
• Education –
nurseries,
schools, colleges,
universities – could
all be provided by the
market but would
everyone be able to afford
them?
Schools: Would you pay if the state
did not provide them?
Market Failure
• Public Goods
• Markets would not provide
such goods and services at all!
• Non-excludability – Person
paying for the benefit cannot
prevent anyone else
from also benefiting - A non-excludable good?
the ‘free rider’ problem
• Non-rivalry –
Large external benefits
relative to cost – socially
desirable but not profitable to
supply!

Would you pay for this?

Market Failure
• De-Merit Goods
• Goods which society over-produces
• Goods and services provided by the market which are not in
our best interests!
• Tobacco and alcohol
• Drugs
• Gambling
Market Failure
• External Costs and Benefits
• External or social costs
• The cost of an economic decision to a third party
• External benefits
• The benefits to a third party as a result of a decision by another
party
Market Failure
• External Costs
• Decision makers do not take
into account the cost imposed
on society and others as a
result of their decision
• e.g. pollution, traffic
congestion, environmental
degradation, depletion of the
ozone layer, misuse of alcohol,
tobacco, anti-social behaviour,
drug abuse, poor housing
 External Costs
MSC = MPC + External Cost
Price The Marginal Social Benefit
Thedifference
TheThe
true MPCtherefore
does not is
take into
curvecost between
(MSB) represents thethe MSC
the
MPC account
(thevalue
MPC
sum ofplus
the
thethe cost
MSB to society
external
benefits cost).
andtothe MSCof
production.
Current output the
represents At welfare
antherefore
levels output
loss level
(100)
consumers in society as a to
of 100, the private cost to the
£12 represent
society
whole –some
supplier
failure –
ofthe
price is £5
element
100private
does per
of
units being market
and social
notunit but the
accurately
produced.
benefits. The Marginal Private
cost
reflect thetotrue
society
cost is
ofhigher than
production.
Cost (MPC) curve represents
this (£12).
Value ofthethecosts negative
to suppliers of

£7 Social Cost producing a given output.

externality (Welfare Loss)

£5 Socially efficient output is where

MSC = MSB

MSB

80 100 Quantity Bought and Sold

Market Failure
• External benefits –
• by products of production and
decision making that raise the
welfare of a third party
• e.g. education and training,
public transport, health
education and preventative
medicine, refuse collection,
investment in housing
maintenance, law and order
 External Benefits
Price There can be a position
where output is less than
would be socially desirable
(education for example?) In
MSC this case, the sum of the
benefits to society is greater

£10 Value ofthan

the positive
the private benefit to the
individual.
externality (Welfare Loss)
Social Benefits
£6.50
Socially efficient output
£5
is where
MSC = MSB
MSB

MPB
100 140
Quantity Bought and Sold
Market Failure
• Inequality:
• Poverty – absolute and relative
• Distribution of factor ownership
• Distribution of income
• Wealth distribution
• Discrimination
• Housing
Market Failure
• Measures to correct market failure
• State provision
• Extension of property rights
• Taxation
• Subsidies
• Regulation
• Prohibition
• Positive discrimination
• Redistribution of income