Market Failure

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A key cause of climate change is the failure of the market system to efficiently allocate resources to deal with extensive negative externalities, specifically those caused by carbon – based gases polluting the atmosphere. Failure in the market system is having a extravagant impact on atmosphere. The allocation of resources is affecting the environment but more specifically the carbon based gases are polluting the atmosphere. This is resulting in global climate change. Potential solutions will be analysed throughout this essay to prevent market failure. The solutions that will be considered are environmental taxation, government regulation and trading in marketable permits e.g. carbon credit market.

Market Failure

Economists recognise two main types of market failure – spillovers and public goods (Jackson, McIver, Bajada 2007: 208). These types of market failure are externalities and in some cases result in over allocation of resources. Spillovers occur when some of the benefits or costs associated with the production or consumption of a good ‘spill over’ to third parties; that is, to parties other than the immediate buyer or seller (Jackson, Mciver, Bajada 2007:204). Externalities are actions of one economic agent that have an impact on other economic agents, in either a negative or positive manner (Magill’s Choice 1999:569). Spillovers can occur under various categories for example the environment.

The other type of market failure is public goods. Public goods are goods and services not provided by the market system, as they are indivisible and often not bound by the exclusion principle (Jackson, Mciver, Bajada 2007:206). Indivisible goods are goods that cannot be divided. The exclusion principle is simply consumers that don’t buy the product are excluded from the benefits. This is related to market failure as public goods are not provided by the market and some cases aren’t able to be purchased. For example, infrastructure provided by the government, it’s a good but consumers can’t purchase it but they utilise it.

Spillover costs are associated with the third parties when there is no compensation. Spillover costs are closely related to climate change as there are costs associated with repairing damage enforced on the environment which affects the third party. Air pollution is one aspect of climate change that affects third parties. The pollution of resources in the atmosphere has been an ongoing issue for many years. Resources such as coal, oil and natural gas has released large quantities of carbon previously locked in underground rock layers and has increased the atmospheric concentration of carbon dioxide by a third (34%) since 1750 (Economist 1990). This is an example of a spillover cost where the third parties aren’t compensated for. Resources have been polluting the atmosphere for years but the third parties are unaware of it. Carbon based gases are polluting the atmosphere resulting in climate change. The global warming caused by this greater concentration of carbon in the air is producing an anticipated speed of climate change greater than anything seen for at least 10,000 years (Economist 1990). Spillover costs regarding air pollution effect the third party as everyone requires oxygen to live, as the allocation of resources around the world continues, third parties are affected by the spillover costs.

When production or consumption of a commodity inflicts costs on some third party without compensation, these are termed spillover costs. An example of a spillover cost is environmental pollution. When a chemical manufacturer dumps wastes into a lake or river, swimmers, people who fish and sail, and whole communities that want a decent water supply suffer spillover costs.

This diagram is an example of market failure, as it demonstrates how spillover coasts affect the allocation of resources. There is an over allocation of resources as more is supplied then what is demanded and the...
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