EC4101 Week 07 Lecture 01 PDF

EC4101 Wk.07 Lec.01 Market Failures: All the circumstances in which market equilibrium is inefficient. A free market will move towards an inefficient equilibrium due to market failures. They are the main reason for government intervention. Sources of disruption that cause market failure: Im...

EC4101 Wk.07 Lec.01 Market Failures: All the circumstances in which market equilibrium is inefficient. A free market will move towards an inefficient equilibrium due to market failures. They are the main reason for government intervention. Sources of disruption that cause market failure: Imperfect Competition: Producers set a price above marginal costs because they have market power. Industries then produce less than they would in an efficient market. Equity, Tax and Public Goods: Taxes drive a wedge between price paid and price received. Public goods are those that are non-rival (one unit can be used by all, e.g. radio) and non-excludable (it is impossible to stop consumption by those who have not paid for the good, e.g. streetlights). Due to the free rider problem, public goods will not be made without intervention (public production, PPEs, private market solutions or private co-operation). Externalities: These arise if one person’s production or consumption physically affects the production or consumption of others, but no one pays/receives compensation. They can be positive or negative. Examples include pollution, noise, congestion and education. There are no markets for externalities so there is no way of ensuring that the marginal benefit equals the marginal cost. They are non-rival and non-excludable. Social Cost/Benefit = Private Cost/Benefit + Externality Cost/Benefit o There are 4 types of externalities, negative production, negative consumption, positive production and positive consumption. o Production externalities make social and private marginal costs diverge. o Consumption externalities make social and private marginal benefits diverge. o Negative externalities lead markets to produce a larger quantity than socially desirable. o Positive externalities lead to markets producing a smaller quantity than socially desirable. Asymmetric Information: Where one party in a market transaction has more information than the other party, leading to opportunism. E.g. insurance markets. There are two types of opportunistic behaviours: o Adverse Selection: (Hidden information or unobserved characteristics) o Moral Hazard: (Hidden actions) Information can be equalised by screening, signalling, third party comparisons, standards and certifications. Opportunistic behaviour can be regulated by actions such as compulsory car insurance and product liability laws. References: Notes based on EC4101 Lecture Slides and the relevant readings from Economics (12th Ed.) David Begg.