MARKET FAILURE
Market failure-when there is a misallocation of resources
=price mechanism leads to a price and quantity which isn't best for society
BC of
● Negative externalities
● Positive externalities
● Public goods
● Information gaps
NEGATIVE EXTERNALITIES
● Costs which affect third parties outside the price mechanism
➔ Negative consumption externalities-the consumer causes the externality=alcohol,cigarettes
➔ Negative production externalities-the producer causes the externality-builders creating noise
pollution
NEGATIVE PRODUCTION EXTERNALITY:
● Producers think about PC and PB not EC and EB because they want to profit maximised
costs
Society considers the social cost and social benefit which is
positive until the socially efficient equilibrium.
After that the welfare turns negative therefore we want to stop
producing at the socially efficient equilibrium but at the market
produces at 8(purple circle)
Thus we overproduce and suffer from a welfare loss=blue
triangle
Welfare loss=how much welfare the society losses out on as
a result of the negative externality bc businesses only think
about private costs not external costs so produce more than
socially efficient level
overproduction
, NEGATIVE CONSUMPTION EXTERNALITY:
Society wants the goods to be produced at the
socially efficient equilibrium where there is less
quantity produced for the good however business
Market equilibrium prudence anr price at the market equilibrium where
they dont consider external costs where there is
overconsumption and overpricing and therefore
leading to a net welfare loss
Socially efficient
equilibrium
INDIRECT TAX:
● Tax on goods and services
● Indirect tax makes production more constantly for producers, increasing the MPC shifting MPC to
MPC+tax
● Thus producers now produce at the Qs the socially efficient equilibrium
But this only works if government gets the correct size of the tax
too small won't reach the MSC
THUS tax has to be equal to the external cost between the MSC
and MPC at the socially efficient equilibrium
-----no more overproduction and welfare loss=negative
production externality is internalised
TRADABLE POLLUTION PERMITS:
Permits which allow firms to pollute up to a certain limit.
● In 200s the Europe's emissions trading scheme started a cap and trade system
● First the EU gov setting a pollution cap which is at the socially efficient level of pollution=2 billion
tonnes of carbon
● Next it divides up the permits between firms until it reaches the cap-1 permit=1 ton of carbon
---firms producing more goods=more permits-thus can pollute a lil more than firms producing less
goods
● Last 10% of permits are then auctioned by the gov=so forms wanting more permits can buy them at
the auction raising revenue for the gov
● Once permits are given out firms can trade these between themselves-firms finding it expensive to
reduce pollution can buy permite from firms having low costs on reducing pollution
MINIMUM PRICES:
● The lowest price suppliers of a good can sell for
● In scotland, the minimum price for one unit of alcohol is
50p=reduced incidents occurring when ppl are intoxicated
● The gov can keep the price of alcohol high-QD low=contraction in
QD-reducing overconsumption
Market failure-when there is a misallocation of resources
=price mechanism leads to a price and quantity which isn't best for society
BC of
● Negative externalities
● Positive externalities
● Public goods
● Information gaps
NEGATIVE EXTERNALITIES
● Costs which affect third parties outside the price mechanism
➔ Negative consumption externalities-the consumer causes the externality=alcohol,cigarettes
➔ Negative production externalities-the producer causes the externality-builders creating noise
pollution
NEGATIVE PRODUCTION EXTERNALITY:
● Producers think about PC and PB not EC and EB because they want to profit maximised
costs
Society considers the social cost and social benefit which is
positive until the socially efficient equilibrium.
After that the welfare turns negative therefore we want to stop
producing at the socially efficient equilibrium but at the market
produces at 8(purple circle)
Thus we overproduce and suffer from a welfare loss=blue
triangle
Welfare loss=how much welfare the society losses out on as
a result of the negative externality bc businesses only think
about private costs not external costs so produce more than
socially efficient level
overproduction
, NEGATIVE CONSUMPTION EXTERNALITY:
Society wants the goods to be produced at the
socially efficient equilibrium where there is less
quantity produced for the good however business
Market equilibrium prudence anr price at the market equilibrium where
they dont consider external costs where there is
overconsumption and overpricing and therefore
leading to a net welfare loss
Socially efficient
equilibrium
INDIRECT TAX:
● Tax on goods and services
● Indirect tax makes production more constantly for producers, increasing the MPC shifting MPC to
MPC+tax
● Thus producers now produce at the Qs the socially efficient equilibrium
But this only works if government gets the correct size of the tax
too small won't reach the MSC
THUS tax has to be equal to the external cost between the MSC
and MPC at the socially efficient equilibrium
-----no more overproduction and welfare loss=negative
production externality is internalised
TRADABLE POLLUTION PERMITS:
Permits which allow firms to pollute up to a certain limit.
● In 200s the Europe's emissions trading scheme started a cap and trade system
● First the EU gov setting a pollution cap which is at the socially efficient level of pollution=2 billion
tonnes of carbon
● Next it divides up the permits between firms until it reaches the cap-1 permit=1 ton of carbon
---firms producing more goods=more permits-thus can pollute a lil more than firms producing less
goods
● Last 10% of permits are then auctioned by the gov=so forms wanting more permits can buy them at
the auction raising revenue for the gov
● Once permits are given out firms can trade these between themselves-firms finding it expensive to
reduce pollution can buy permite from firms having low costs on reducing pollution
MINIMUM PRICES:
● The lowest price suppliers of a good can sell for
● In scotland, the minimum price for one unit of alcohol is
50p=reduced incidents occurring when ppl are intoxicated
● The gov can keep the price of alcohol high-QD low=contraction in
QD-reducing overconsumption
