MARKET FAILURE AND GOVERNMENT INTERVENTIONSAllocative Efficiency and Market Failure

STARTER

Define opportunity cost. “There are limited resources relative to wants” is

the basis of which economic concept? When are PPC’s drawn with straight lines? When a PPF is bowed outwards what is it

showing?

PRODUCTION EFFICIENCY

All points on a PPC frontier show production efficiency because at these points resources are fully employed and put to their best possible use.

Consumer Goods

CapitalGoods

ALLOCATIVE EFFICIENCY

The point which represents the combination of goods that consumers want. By changing the combination of goods you can not make somebody better off without making somebody else worse off. Consumer

Goods

CapitalGoods

PRODUCTION INEFFICIENCY

If the point is inside the PPC it is a production inefficiency point. Not all resources are fully utilised.

Consumer Goods

CapitalGoods

CONDITIONS TO ACHIEVE ALLOCATIVE EFFICIENCY

Consumer Sovereignty (The consumer knows best)

Consumers are the best judge of what is good for them.

Perfect Information All consumers are well informed enabling them

to make sensible decisions.

CONDITIONS TO ACHIEVE ALLOCATIVE EFFICIENCY

Perfect Mobility of Factors Capital resources and human resources Factors of production must shift into the

activities that best represent the consumers wants and needs.

CONDITIONS TO ACHIEVE ALLOCATIVE EFFICIENCY

Perfect Competition Firms must be price takers

A homogeneous or identical product; Numerous buyers and sellers, none large enough to

influence the price. Freedom of entry or exit from the market.

CONDITIONS TO ACHIEVE ALLOCATIVE EFFICIENCY

Fair income distribution Let the market forces set the wage rates for

different professions. High demand for doctors, low supply, so doctors

get a high wage. There is a demand for supermarket workers, but

the high supply of potential supermarket workers pushes the wage rate of supermarket workers down.

No externalities What about goods that incur costs or benefits to others?

Externalities. The market won’t take account of the cost and benefit to

others so if externalities are present the market is not allocative efficient.

Externality Cost to others Benefit to others

Pollution in a river

Courtney takes the bus to school

Drinking alcohol

Fishermen down stream

Less congestion onthe road for everyone else.

Damage to property

No Public Goods

When price signals are not clear the market breaks down.

The private sector won’t produce goods with unclear price signals.

These goods are called public goods and the market fails to produce these goods.

MARKET FAILURE Those six conditions are not met so market

failure occurs. New Zealand is currently at an inefficient point

inside the PPC where it is possible to make somebody better off with out making others worse off. Consumer

Goods

CapitalGoods

State Intervention

MARKET FAILURE AND GOVERNMENT INTERVENTIONS

THE GOVERNMENT

If perfectly competitive markets are left on their own they may fail to provide an efficient and fair allocation of resources so the government steps in.

ROLES OF THE GOVERNMENT

Regulatory role Allocative role Distributive role Stabilisation role

REGULATORY ROLE

The rules that are established to make the market system work effectively.

Employment Relations Act, Fair Trade Act and the Consumer Guarantees Act.

ALLOCATIVE ROLE

The government must determine how some resources are allocated.

Collective goods such as roads, education and health.

DISTRIBUTIVE ROLE

The free market outcome results in an unfair distribution of income, so the will intervene to assure everyone has a sufficient income.

They do this through benefits, state housing and educational courses.

STABILISATION ROLE

The government intervenes in the market to ensure there is steady growth.

They do this through monetary and fiscal policy. We have just seen the OCR drop from above 8%

down to 2.5% and it is now steadily rising again.

GOVERNMENT INTERVENTION

Taxes- a compulsory payment to the government.

Subsidy- a payment by government to firms to keep costs low.

Transfer payments- a payment made by the government with nothing in return.

PRIVATE AND PUBLIC GOODS

PRIVATE GOODS

A private good is a good or service which a person will be excluded from owning or using if they do not pay for it.

Market forces achieve the best allocation of resources, allowing consumer and producer surpluses to be maximised.

CHARACTERISTICS OF PRIVATE GOODS

Rival (depletable)- if one person consumes a good the benefits of it are not available for others.

Excludable by price- Individuals can only consume the good if they pay for it.

The market is good at producing private goods. Firms are willing to produce goods that they can charge for as this will generate profit.

PUBLIC GOODS

Price signals for public goods are non-existent because the goods are non-excludable by price and they are non-rival.

Once a public good is provided then it is impossible to stop someone else using the good or service. Individuals who do not pay can not be excluded from using the public good.

Non-rival- If one person has the public good, others can use it with no extra resources or cost required.

MIXED GOODS Mixed goods are goods that can be provided by

the government or the private sector. They have a private aspect that can be marketed or sold.

THE FREE RIDER PROBLEM

When people refuse to contribute to the cost of providing a public good on the grounds that once it is provided no one can be excluded from using it.

In this situation private producers will have no incentive to produce the goods as they have no way of charging for the product so they can’t make a profit.

SOLUTION

The government raise money through taxation to provide public goods.

Hospital High School Police Army

Roads Bridges Medical Drugs University

Dentist Visits Navy Air Force Cycle Helmets

Cigarettes McDonalds Net Ball Courts Gambling

Eye Examinations

Seatbelts Cars with ASB breaks

Snowboard

Milk Recycling Plant Slippers Electric Blankets

Alcohol Guns Cycle Ways Sports Stadiums

Rubbish Collection

Swimming Pools

Park Street Lamp

MERIT GOODS

A merit good is a good that society or the government deems that people ought to have because it is considered to be good, consumption is encouraged.

The government may encourage consumption by provide these goods free of direct charge, by providing a subsidy or by compulsion.

DEMERIT GOODS

A demerit good is a good that government or society deems to be harmful or bad for people.

The government may prohibit consumption or impose taxes on goods.

Hospital High School Police Army

Roads Bridges Medical Drugs University

Dentist Visits Navy Air Force Cycle Helmets

Cigarettes McDonalds Net Ball Courts Gambling

Eye Examinations

Seatbelts Cars with ASB breaks

Snowboard

Milk Recycling Plant Slippers Electric Blankets

Alcohol Guns Cycle Ways Sports Stadiums

Rubbish Collection

Swimming Pools

Park Street Lamp

COLLECTIVE GOODS

A collective good is a good provided by the government that is free of direct charge paid for by taxes.

Collective goods have an opportunity cost. The more collective goods we have the less private goods we have.

Collective goods should be provided up to the point at which MSC=MSB

PRODUCTION POSSIBILITIES CURVE

Private goods

Collective goods

A

B

CHARGING FOR PUBLIC GOODS

Once a public good is provided it does not cost any more for others to gain benefit through using it.

Thus excluding people from using the good would be inefficient.

E.g. Toll on bridge.

CHARGING FOR A PUBLIC GOODMB

Charge

Price

Welfare lost through charging for public good.

Capacity of the public good

Quantity

TAXES AND SUBSIDIES ON GOODS.

Governments can tax demerit goods and subsidise merit goods.

TAX

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SUBSIDY

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