Market Failures Overview

Market Failures

• Market failures occur when the market does not efficiently allocate resources.
• This results in either overproduction or underproduction of goods and services.
• Overallocation occurs when resources are used to produce more of a good than desired.
• Underallocation occurs when resources are used to produce less of a good than desired.

Types of Market Failures

• Externalities: Costs or benefits that affect third parties not directly involved in a transaction.
  • Negative externalities: Costs imposed on third parties (e.g., pollution).
  • Positive externalities: Benefits received by third parties (e.g., education).
• Public Goods: Goods that are non-excludable (difficult to prevent people from consuming) and non-rivalrous (one person's consumption doesn't reduce another's).
  • Examples include national defense, public parks, and street lighting.
• Imperfect Information: When one or both parties to a transaction have imperfect information regarding a product or service.
• Market Power: The ability of a single firm or a small group of firms to influence the market price.
  • This can lead to underproduction and higher prices.
  • Examples include monopolies and oligopolies.

The Coase Theorem

• The Coase Theorem suggests that, under certain conditions, private bargaining can solve externality problems without government intervention.
• These conditions include well-defined and enforceable property rights, a small number of parties involved, and low transaction costs.

Government Intervention

• Government intervention may be necessary when private bargaining is not an effective solution.
• It can involve taxes, subsidies, regulations, or market-based solutions like cap-and-trade systems to correct externalities.
• Government intervention can involve unintended consequences and high costs.

Efficient Markets

• In efficient markets, resources are allocated in a way that maximizes societal welfare.
• This occurs when the demand curve reflects consumer willingness to pay and the supply curve reflects all production costs, including externalities.
• An efficient market produces the equilibrium quantity of goods and services at the lowest cost.

Surplus

• Consumer surplus: The difference between the maximum price a consumer is willing to pay for a good and the actual price they pay.
• Producer surplus: The difference between the price a producer receives for a good and the minimum price they are willing to accept.

Productive Efficiency

• Productive efficiency occurs when goods and services are produced at the lowest possible cost, using available resources efficiently.
• This typically corresponds to producing at the minimum point of the average cost curve.

Allocative Efficiency

• Allocative efficiency occurs when resources are allocated to produce the goods and services that society values most.
• This corresponds to producing where marginal cost equals marginal benefit.