2.8 Market Failure
Market Failure
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Market failure is when a freely functioning market without any government intervention fails to achieve allocative efficiency and a socially optimum level of output;
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If at any point from the society’s perspective there is lack of efficiency in the allocation of resources, market failure will be present
Reasons for market failure
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Lack of Public goods, as stated in unit 2.7 Firms will not provide public goods due to their non-excludable[Users need not pay for the good] and can be non rival[unlimited in supply].
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Overconsumption of demerit goods and underconsumption of merit goods; this can cause unwanted negative externalities and private costs too.
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Common Pool Resources; resources that are non excludable but rival
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Asymmetric Information; Generally producers tend to have more information about markets than the consumers that puts them at an advantage.
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Informal Markets, profits and consumption from these markets go unnoticed by the government and hence untaxed.
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Environmental degradation; can cause negative externalities, more pollution leading to health issues for example.
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Immobility of resources; this is when resources can not be moved between places where they will be used most efficiency hence inefficiency is present.
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Exploitation of monopoly power; Monopolies[ we take perfect monopoly ] where one seller controls the industry, they can exploit consumers easily
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**Externalities are effects of the good on people who have neither purchased nor produced the good, can be beneficial or detrimental**
Socially optimal level of output and terms
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Marginal private benefit; The additional benefit to the first and second party[producers and consumers, together mean private] received by the consumption and production of 1 unit of a good
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Marginal private cost; The additional costs to the private party due to the consumption and production of 1 unit of a good
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Marginal Social benefit; The additional benefit for the whole society[ first second and third party; who are not a part of the consumption or production] from the production and consumption of 1 unit of a good
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Marginal Social Cost; The additional cost for the whole society from the production and consumption of 1 unit of a good.
What are trade unions
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Trade unions represent employees in workplace conflicts. They protect their members' rights and welfare, and negotiate with employers on issues like:
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Pay: Increased wages or prevented cuts.
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Remuneration: Improved benefits and holidays.
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Working conditions: Better hours and breaks.
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Training and development: Opportunities for growth.
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Staff facilities: Improved amenities.
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Unions provide collective bargaining power, making it more effective for employees to negotiate with employers. They also offer legal advice and representation in disputes.
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Membership fees contribute to union operations, including legal costs and advocacy efforts.
Socially optimal output
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This is when Marginal Social Benefit[MSB]=Marginal Social Costs[MSC]
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Also the point at which allocative efficiency and Social surplus is maximised
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Negative Externalities
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The overproduction of demerit goods.
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Too many resources are being allocated for this good as only private benefits and costs are being considered.
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Optimum allocation would be at MSB=MSC.
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Conversely a diagram for Underproduction of merit goods would look similar, only where supply would be the supply curve on the left, and MSC would be on the right.
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It is to be noted that production of merit goods can also cause negative externalities, like pollution for electricity
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Negative Externalities
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Overconsumption of demerit goods
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Demand is too high as consumers undermine the costs to the society of this good[ often because these goods are addictive]
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Optimum allocation would be at MSB=MSC.
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Conversely a diagram for Underconsumption of merit goods would look similar, only where demand would be the demand curve on the left, and MSB would be on the right.
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These externalities can be reduced by government intervention like indirect taxation. Price controls, subsidies to merit goods.
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Positive Externalities
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As said earlier when there is Underproduction of merit goods a positive externality will be absent, as producers are only taking into account private benefits
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Positive Externalities
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There is underconsumption of merit goods as consumers undermine / are unaware of the benefits of the good to the society. There is an absent positive externality.
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More resources need to be allocated to achieve the socially optimal level of output, which can be achieved with government intervention; subsidies.
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Common Pool Resources
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As said these are non excludable but rival goods, meaning anyone can use it but they are finite in supply thus not everyone may be able to use it.
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When they are used unsustainably then it creates negative externalities of production; enviromental damage and resource depletion
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Examples are rainforests and fishing in international waters.
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To solve this issue the resources can be privatised; people get to own them, Laws can be made like fishing quotas for the fishing example. A lesser solution is to identify and promote more sustainable alternatives.
Monopoly
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Monopolies can cause market inefficiency, limit innovation and healthy competition[if imperfect monopoly] as these are price makers as opposed to in actual competitive markets where no 1 supplier can set the price. The price mechanism cannot function properly if monopoly powers are abused.
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Due to little to no innovation as there are little to no pressures to have to become more efficient and competitive, the market stagnates and will not evolve.
Government Intervention
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Indirect taxes; When it is levied on the demerit goods, it will increase the price and thus decrease demand for the product and also increase government revenue which can be spent on other policies like; Overproduction and overconsumption of demerit goods
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Subsidies; Government gives funds to producers to reduce costs and promote production of merit goods. Subsidies will most likely be per unit produced of the merit good. For underproduction and underconsumption of merit goods
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Carbon credits and Tradable permits; Carbon credits allow producers to emit a certain amount of greenhouse gases. These must be bought however if a firm has an excess of these they can sell it to other producers. For environmental damage
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Carbon tax; A government imposed fee on the emission of greenhouse gases. Thus it should reduce the supply as it would increase costs[more than normal and eat into profits] at higher production levels. For environmental damage
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Legislation and regulations; Laws are created and agencies are created to enforce them.
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Education; Government can spend on advertising campaigns to spread awareness of the benefits of merit goods and consequences of demerit goods. Demerit and merit goods.
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Direct provision; Governments will provide goods themselves so that everyone in the society can have access to the goods. Underproduction of goods
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International agreements; Can be used for global issues like climate change and need global coordination, useful for trade of demerit goods
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Collective self governance; When local communities act to address the market failure by working together to reduce negative externalities