market forces fail to achieve economically efficient outcomes.

market forces fail to achieve economically efficient outcomes.

EXAMPLES OF MARKET FAILURE Externalities Public goods Merit and de-merit goods Factor immobility Poor information Monopolies Inequalities in distribution Macroeconomic problems

Reasons Why Markets Fail to Attain an Ideal Allocation of Resources lack of competitive rivalry and an inoperative price mechanism, Non exclusivity and the existence of public goods, externalities.

EXTERNALITIES Externalities are defined as third party (or spill over) effects arising from the production and/or consumption of goods and services, for which no appropriate compensation is paid. Government could require those causing external costs to pay compensation for damages or to refrain from production. Equally, through: regulation, subsidies and tax policy, the government could promote the supply of goods with external benefits.

PUBLIC GOODS CHARACTERISTICS NON-EXCLUDABILITY and NON RIVALRY Because of their nature, the private sector is unlikely to be willing and able to provide public goods. Street lighting Police Services Flood defence systems Lighthouse protection The government therefore provides them for collective consumption and finances them through general taxation.

MERIT GOODS Goods, the consumption of which is deemed to be intrinsically desirable Education Health Government may decide to increase the supply of such goods to a more socially desirable level and pay for these services from general taxation.

DEMERIT GOODS Goods, the consumption of which should be discouraged. Alcohol Drugs Government discourages production and consumption of these merit bads.

FACTOR IMMOBILITY The factor market does not work efficiently. In the case of the labour market government intervention may take the form of: minimum wage fixing, training or even factor allocation.

POOR INFORMATION For the price mechanism to work efficiently it is important that there be perfect information, both in the product market and in the factor market. In the absence of this, both markets will fail.

MONOPOLIES Under monopoly price is higher and output is lower Monopolies are allocative inefficient and productive inefficient X-inefficiency may also result if the monopolist allows cost efficiency to drop Rent seeking behaviour of monopolist goes against the interest of consumers To prevent consumer exploitation by such industries, governments either own or run such industries in the national interest (i.e. nationalise them, or regulate them in terms of prices, product quality and profits)

MACROECONOMIC PROBLEMS At the macro level, government manages the economy at achieve its objectives of: Full Employment Price stability Balance of Payments Equilibrium Economic Growth A Fair Distribution of Income Balanced Budget

Environmental policies Direct controls (output quotas) Tax on output ("make the polluter pay") Subsidising 'good' behaviour Emissions fees (pollution taxes) Tradeable permits (marketable permits)

Costs & Benefits Marginal Social Cost Marginal Private Cost P2 P1 Deadweight loss of social economic welfare Qa Qb Marginal Private Benefit (Assumed equal to MSB) Quantity Private optimum output (Qb), exceeds the social optimum (Qa), leading to the loss of social economic welfare to society. Taxes may help in retaining some of this welfare ( Inward shift of supply curve).

How Pollution Taxes Work Costs Benefits P0 + T P1 + T MSC MPC + tax MPC P0 MPB Qs Qp Output produced

Taxation of negative externalities Designed to make the polluter pay for some of the external costs they cause, Taxes will increase the costs of production - i.e. they internalise the externalities, This should cause the producer / consumer to reduce their output / consumption Lower output should reduce the social bad such as pollution

Problems with environmental taxes Who is causing the pollution? Can we put a monetary value on pollution? Do we tax polluters the same amount? Demand may be inelastic - Producers may pass on a tax to consumers Requires high taxes to have significant effect Low-income consumers may not be able to pay Taxation can have distortionary effects Higher taxes might cause inflation

Green Taxes What is and what might be taxed? Cigarettes and Alcohol Motor Fuels Agricultural fertilisers & pesticides Disposable household goods Household & Industrial Waste disposal Water usage Car parking

Coase Theorem An acceptable solution to an externality would be found through private negotiation if: ownership of property is clearly defined, the number of people involved is small, the costs of bargaining are negligible.

BUT Not only do markets fail but so do governments. Some Economists believe that even with good intentions, Governments seldom get their policy application correct. They can tax, control and regulate, but the outcome will be a deepening of the failure, or even worse, creating new problems.