PIB MARKET FAILURE

Important terms

Public goods: goods that can be used by the general public, from which they will

benefit. Their consumption cannot be measured, and therefore cannot be

charged a price for (this is why a market economy doesn’t produce them).

Examples include street lights and roads.

Merit goods: goods which create a positive effect on the society and must be

consumed more. Examples include schools and hospitals.

Demerit goods: goods which create a negative effect on the society and must

be consumed less. Examples include alcohol, video games and cigarettes.

Important terms

External costs (negative externalities) are the negative impacts on society

(third-parties) due to production or consumption of goods and services. Example: the

pollution from a factory.

External benefits (positive externalities) are the positive impacts on society due to

production or consumption of goods and services. Example: better roads in a

neighbourhood due to the opening of a new business.

Important key terms

Private costs are the costs to the producer and consumer due to production
and consumption respectively. Example: the cost of production.

Private benefits are the benefits to the producer or consumer due to
production and consumption respectively. Example: the better immunity
received by a consumer when he receives a vaccine.

Social Costs = External costs + Private Costs

Social Benefits = External benefits + Private benefits

Market Failure

Market failure occurs when the fails to allocate resources effectively. This is the most

disadvantageous aspect to the market economy. Causes of market failure are:

●When social costs exceed social benefits (especially where negative externalities (external

costs) are high).

●Over-provision of demerit goods like alcohol and tobacco: the external costs arising from

demerit goods are not reflected in the market and so they are overproduced.

●Under-provision of merit goods such as schools, hospitals and public transport, since the

external benefits of these goods are not reflected in the market, they are underproduced.

Market Failure

Market failure occurs when the fails to allocate resources effectively. This is the

most disadvantageous aspect to the market economy. Causes of market failure are:

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Lack of public goods such as roads, bus terminals and street lights: since their

consumption cannot be measures and charged a price for, they are not produced

by the private sector.

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Immobility of resources: when resources cannot move between their optimal

uses and thus are not used to the maximum. For example, when workers (labour)

don’t have occupational or geographic mobility.

Market Failure

Market failure occurs when the fails to allocate resources effectively. This is the

most disadvantageous aspect to the market economy. Causes of market failure are:

❖

Information failure: when information between consumers, producers and the

government are not efficiently and correctly communicated. Example: a cosmetics

firm advertises its products as healthy when it is in fact not. The consumers who

believe the firm and use its products might suffer skin damage.

❖

Abuse of monopoly* powers: monopolistic businesses may use their powers to

charge consumers a high price and only produce products they wish to, since they

know consumers have no choice but to buy from them.

Mixed Economic System

●In a mixed economic system, both the market and government intervention co-exist.

Examples include almost all countries in the world.

●Mixed economy overrides all the disadvantages of both the market and planned (govt.

only) economies.

●It identifies the importance of the price mechanism in operating an efficient resource

allocation and also the role of the government in correcting (any) market failures.

Features:

●both the public and the private sector exists

●planning and final decisions are made by the govt. while the market system can

determine allocation of resources owned by it, along with the public organizations.

Mixed Economic System

Advantages:

●The govt. can provide public goods, necessities and merit goods. The private businesses

can provide profitable and most-demanded goods (luxury goods, superior goods). Thus,

everyone is provided for.

●The govt. will keep externalities, monopolies, harmful goods etc. in control.

●The govt. can provide jobs in the public sector (so there is better job security).

●The govt. can also provide financial help to collapsing private organizations, so jobs are

kept secure.

Mixed Economic System

Disadvantages:

●Taxes will be imposed, which will raise prices and also reduce work incentive.

●Laws and regulations can increase production costs and reduce production in the

economy.

●Public sector organizations will still be inefficient and will produce low quality goods and

services.

Correcting marketing failures.

There are specific ways in which the government, in a mixed economic system, can correct market failures
of the market:

1. Legislation and regulation

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The government can make laws that regulate market activity, for example,

prohibit smoking in public

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One important kind of legislation the government can undertake is price

controls – setting a minimum price or maximum price on goods.

❖

Minimum price or price floor is set to control a decreasing tendency of price.

The minimum wage laws in many countries are an example of minimum price.

❖

The government sets the minimum wage above the existing market equilibrium

wage, to ensure that all workers get a basic minimum wage to sustain them.

1. Legislation and regulation

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But even as low-income workers now get better

wages, the higher wage will cause the demand for

labour to contract, as shown in the diagram to the

left.

❖

There will also be higher supply of labour (workers

who want work) because of higher wages.

❖

A reduced demand and increased supply will cause

excess supply of labour i.e., unemployment