Economics Section 4.1.8- Market Failure
Negative Externalities
Third party effects arising from production and consumption for which no appropriate compensation is paid
Occurs outside of the market
PROPERTY RIGHTS
One of the main issues involved in negative externalities are Property Rights- Legal control or ownership of
assets
For a market to be efficient, property rights must be protected, usually through regulation
Failure to protect these property rights could lead to the TRAGEDY OF THE COMMONS, where the over use
could lead to long-term permanent damage to the stock of natural resources, e.g. over-fishing as a result of
a lack of regulation
When negative production externalities exist, Social costs (Third party) exceed Private costs (First party)
When negative consumption externalities exist, Private benefits exceed social benefits
The socially efficient output would be Q2 at the price P2, where the external costs have been taken into
account
GOVERNMENT INTERVENTION
1) Pollution Taxes
-Increases the marginal cost, causing a fall in demand and a reduction in the level of pollution
-Tax payed can be used for better purposes, eg. Healthcare
2) Carbon Trading
-EU has set a decreasing cap for CO2 for energy intensive firms
-Firms pay more for more emissions, hence increasing incentive to cut down
-A bid to create a market in pollution permits and put a price on carbon
-However, there has been an oversupply, which has caused the price of permits to collapse
, 3) Regulation
-Regulations and laws have been put in place in an attempt to change the behaviour of consumers and
firms regarding negative externalities
EVALUATION
1) There have been problems in setting the right tax as it is difficult to measure when the private costs will
exactly equate with the social costs
2) If the demand for a good is inelastic, producers may pass on the tax to consumers and the tax will have
little or no change to the demand for the good
3) May cause inequality- a regressive tactic where the lower income households tend to consumer more
goods with negative externalities
4) Regulating negative externalities may act as a spur for future innovation, e.g. renewable energy
5) If intervention is toughened each year, capital investment will be stimulated
6) GOVERNMENT FAILURE
POSITIVE EXTERNALITIES
When a good is under-consumed or under-provided in a free market as the free market.
If there are external benefits, the market delivers an output below the socially maximising point
Negative Externalities
Third party effects arising from production and consumption for which no appropriate compensation is paid
Occurs outside of the market
PROPERTY RIGHTS
One of the main issues involved in negative externalities are Property Rights- Legal control or ownership of
assets
For a market to be efficient, property rights must be protected, usually through regulation
Failure to protect these property rights could lead to the TRAGEDY OF THE COMMONS, where the over use
could lead to long-term permanent damage to the stock of natural resources, e.g. over-fishing as a result of
a lack of regulation
When negative production externalities exist, Social costs (Third party) exceed Private costs (First party)
When negative consumption externalities exist, Private benefits exceed social benefits
The socially efficient output would be Q2 at the price P2, where the external costs have been taken into
account
GOVERNMENT INTERVENTION
1) Pollution Taxes
-Increases the marginal cost, causing a fall in demand and a reduction in the level of pollution
-Tax payed can be used for better purposes, eg. Healthcare
2) Carbon Trading
-EU has set a decreasing cap for CO2 for energy intensive firms
-Firms pay more for more emissions, hence increasing incentive to cut down
-A bid to create a market in pollution permits and put a price on carbon
-However, there has been an oversupply, which has caused the price of permits to collapse
, 3) Regulation
-Regulations and laws have been put in place in an attempt to change the behaviour of consumers and
firms regarding negative externalities
EVALUATION
1) There have been problems in setting the right tax as it is difficult to measure when the private costs will
exactly equate with the social costs
2) If the demand for a good is inelastic, producers may pass on the tax to consumers and the tax will have
little or no change to the demand for the good
3) May cause inequality- a regressive tactic where the lower income households tend to consumer more
goods with negative externalities
4) Regulating negative externalities may act as a spur for future innovation, e.g. renewable energy
5) If intervention is toughened each year, capital investment will be stimulated
6) GOVERNMENT FAILURE
POSITIVE EXTERNALITIES
When a good is under-consumed or under-provided in a free market as the free market.
If there are external benefits, the market delivers an output below the socially maximising point
