Why Do Markets Fail?
Why do some markets fail?
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Market Failure
Market failure – occurs when the price mechanism causes an inefficient allocation of resources and a net welfare loss in society, so resources are not allocated to their best/optimum use. Identifying market failure is difficult because it involves making a value judgement about what is good and what is bad for an economy. However, it can be decided what is good or bad to society. Goods may be bad because of the nature of the good or because some goods are overprovided and over consumed whereas others are underprovided and under consumed.
Externalities
Externalities are costs or benefits which are external to a transaction – third party effects ignored by the price mechanism.
They are known as indirect costs and benefits or as spillovers from production or consumption of a good or service.
External costs are negative externalities and external benefits are positive externalities.
Social optimum equilibrium: * Social optimum equilibrium occurs where the MSC equals MSB. * The social cost of producing the last unit of output equals the social benefit from consuming it. * At this point, welfare is maximised.
Private Costs: * Producers concerned with the private costs of production. * Costs – wages, rent, payment for raw materials, machinery costs, electricity and gas costs, insurance, packaging, transport costs etc. * Determines supply. * Private costs may also refer to the market price a consumer pays for a good/service – cost to the individual.
Social Costs: * Private costs + external costs = social costs. * External costs are the difference between private and social costs, or the vertical distance between the two curves. * The MSC and MPC curves often diverge – external costs increase disproportionately with output.
Private Benefits: * Consumers only concerned with the private benefits or
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Market Failure
Market failure – occurs when the price mechanism causes an inefficient allocation of resources and a net welfare loss in society, so resources are not allocated to their best/optimum use. Identifying market failure is difficult because it involves making a value judgement about what is good and what is bad for an economy. However, it can be decided what is good or bad to society. Goods may be bad because of the nature of the good or because some goods are overprovided and over consumed whereas others are underprovided and under consumed.
Externalities
Externalities are costs or benefits which are external to a transaction – third party effects ignored by the price mechanism.
They are known as indirect costs and benefits or as spillovers from production or consumption of a good or service.
External costs are negative externalities and external benefits are positive externalities.
Social optimum equilibrium: * Social optimum equilibrium occurs where the MSC equals MSB. * The social cost of producing the last unit of output equals the social benefit from consuming it. * At this point, welfare is maximised.
Private Costs: * Producers concerned with the private costs of production. * Costs – wages, rent, payment for raw materials, machinery costs, electricity and gas costs, insurance, packaging, transport costs etc. * Determines supply. * Private costs may also refer to the market price a consumer pays for a good/service – cost to the individual.
Social Costs: * Private costs + external costs = social costs. * External costs are the difference between private and social costs, or the vertical distance between the two curves. * The MSC and MPC curves often diverge – external costs increase disproportionately with output.
Private Benefits: * Consumers only concerned with the private benefits or