Market Failure
So, what is market failure? We've just been looking at how the most important forces in economic theory, supply and demand, help us allocate resources in the most efficient way possible.....but is this enough to explain the economic world around us? Does our everyday existence reflect these forces in their pure, simplistic efficiency? Of course not...
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The economic world in which we live is messy, complicated....and over the last 100 years or so increasingly dominated by the actions of governments. The huge population increase and technological revolution the world has witnessed since the end of WW2 has seen our lives transformed into an existence unrecognisable to our ancestors. Governments are now required to act in every area of our economic existence alongside the market forces of supply and demand to ensure economies continue to progress and grow. This extension of government activity is known as market failure, and refers to the economic activity that requires government intervention as a result of the market either producing or consuming too much or too little...
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How many examples of market failure can you identify in the picture above?
1 Sources of market failure
a) Why market failure occurs:
- too much or too little of a good is produced and/or consumed compared to the socially optimal level of output.
b) Sources of market failure:
• externalities
• the free-rider problem; non-provision of public goods
• imperfect market information
• moral hazard • speculation and market bubbles.
2 Positive and negative externalities
a) The distinction between private benefits, external benefits and social benefits.
b) The distinction between private costs, external costs and social costs.
c) The distinction between:
• external benefits of production
• external benefits of consumption
• external costs of production
• external costs of consumption.
d) The use of diagrams, using marginal analysis, to illustrate:
• the external benefits from consumption
• the external costs from production
• the distinction between the market and social optimum positions; identification of the welfare loss or gain areas.
e) The impact of externalities in various contexts:
• transport • health • education • environment • financial.
3 Non-provision of public goods
a) The distinction between public and private goods:
• private goods: rival and excludable
• public goods: non-rival and non-excludable.
b) Why public goods may not be provided by the private sector making reference to the free-rider problem.
4 Imperfect market information
a) The distinction between symmetric and asymmetric information.
b) The significance of information gaps.
c) How imperfect market information may lead to a misallocation of resources in various contexts:
• healthcare • education • pensions • insurance.
5 Moral hazard
a) How moral hazard can occur.
b) The impact of moral hazard on consumers, producers, workers and governments in:
• insurance • banking.
6 Speculation and market bubbles
a) How market bubbles may arise.
b) The impact of market bubbles on consumers, producers, workers and governments in various contexts:
• housing • stocks and shares
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