Market Failure

Market Failure• Definition:• Where the market mechanism fails to

allocate resources efficiently– Social efficiency– Allocative Efficiency– Technical Efficiency– Productive Efficiency

Market Failure Social Efficiency = where external

costs and benefits are accounted for Allocative Efficiency = where society

produces goods and services at minimum cost that are wanted by consumers

Technical Efficiency = production of goods and services using the minimum amount of resources

Productive Efficiency = production of goods and services at lowest factor cost

Market Failure Allocative efficiency:

Also referred to as Pareto Efficient Allocation –

resources cannot be readjusted to make one consumer better off without making another worse off – zero opportunity cost! After Vilfredo Pareto (1848 – 1923)

Market Failure Market Failure occurs where:

Knowledge is not perfect - ignoranceGoods are differentiatedResource immobilityMarket powerServices/goods would or could not be

provided in sufficient quantity by the market

Existence of external costs and benefitsInequality exists

Market Failure Imperfect Knowledge:

Consumers do not have adequate technical knowledge

Advertising can mislead or mis-informProducers unaware of all opportunitiesProducers cannot accurately measure

productivityDecisions often based on past

experience rather than future knowledge

Market Failure• Goods/Services are

differentiated– Branding– Designer labels - they cost

three times as much but are they three times the quality?

– Technology – lack of understanding of the impact

– Labelling and product information

Which one is the ‘quality’ item and why?

Market Failure Resource Immobility

Factors are not fully mobileLabour immobility – geographical and

occupationalCapital immobility – what else can we

use the Johor Causeway (Tambak Johor) for?

Land – cannot be moved to where it might be needed – e.g. Bukit Antarabangsa and Sintok!

Market Failure: Market Power:Existence of monopolies and oligopoliesCollusion - an agreement among firms to divide the market, set

prices, or limit production

Price fixing – agreement among sellers to increase price to boosts profit

Abnormal profits – excess profit skept hide to reduce the chance of competition, or government intervention

Rigging of markets - An illegal act or practice in which a person or company causes a price to be more favorable to an investor than market forces really justify

Barriers to entry - protect incumbent firms from competition from newcomers – able to strengthen firm’s price power

Market Failure• Inadequate Provision:• Merit Goods and Public Goods

– Merit Goods – Could be provided by the market but consumers may not be able to afford or feel the need to purchase – market would not provide them in the quantities society needs

– Sports facilities?

Market Failure• Merit Goods• Education

• nurseries, schools, colleges, universities – could all be provided by the market but would everyone be able to afford them?

Schools: Would you pay if the state did not provide them?

An Estimation of Education Cost for a Bachelor’s DegreeProgramme in Arts & Business (per year) in Various CountriesCountry Tuition Fees Living Cost Total Cost

Australia (public) USD 8,500 USD 8,500 USD 17,000

Canada (public) USD 7,500 USD 9,000 USD 16,500

France (public) minimal USD13,000 USD 13,000

Malaysia (private) USD4,600 USD4,000 USD9,000

New Zealand (public) USD 10,000 USD 11,500 USD 21,500

Singapore (private) USD 6,500 USD 10,000 USD 16,500

United Kingdom (public) USD 14,000 USD 12,500 USD 26,500

USA (public) USD 13,000 USD 12,000 USD 25,000

USA (private) USD 22,000 USD 13,000 USD 35,000

Source: Study in Malaysia Handbook (International Edition) & various related websites

Market Failure• Public Goods

• Markets would not provide such goods and services at all!

• Non- excludability• Person paying for the benefit

cannot prevent anyone else from also benefiting - the ‘free rider’ problem

• Non- rivalry • Large external benefits relative

to cost – socially desirable but not profitable to supply!

• consumption of the good by one individual does not reduce availability of the good for consumption by others

A non- excludable good?

Would you pay for this?

Excludability a good or service is said to be

excludable when it is possible to prevent people who have not paid for it from having access to it, and non-excludable when it is not possible to do so.

Rivalry Rival goods are goods whose

consumption by one consumer prevents simultaneous consumption by other consumers.

Non-rival goods may be consumed by one consumer without preventing simultaneous consumption by others.

Excludable Non-excludable

RivalryPrivate goodsfood, clothing, cars, personal electronics

Common goods (Common-pool resources)fish stocks, timber, coal, national health service

Non-rivalryClub goodscinemas, private parks, satellite television

Public goodsfree-to-air television, air, national defense

Market Failure• De-Merit Goods

•Goods which society over-produces

•Goods and services provided by the market which are not in our best interests! – unhealthy, degrading and negative effects.–Tobacco and alcohol–Drugs–Gambling–Prostitution– Junk Food

Market Failure• External Costs and Benefits

•External or social costs (negative)–The cost of an economic decision to a third party

•External benefits (positive)–The benefits to a third party as a result of a decision by another party

Market Failure• External Costs• Decision makers do

not take into account the cost imposed on society and others as a result of their decision– e.g. Pollution, traffic

congestion, environmental degradation, depletion of the ozone layer, misuse of alcohol, tobacco, anti-social behaviour, drug abuse, poor housing

Market Failure• External benefits –

– by products of production and decision making that raise the welfare of a third party

– e.g. Education and training, public transport, health education and preventative medicine, refuse collection, investment in housing maintenance, law and order.

Market Failure• Inequality:

– Poverty – Absolute and Relative– Distribution of factor ownership– Distribution of Income– Wealth Distribution– Discrimination– Housing

Market Failure Measures to Correct

Market Failure– State Provision– Extension of property

rights– Taxation– Subsidies– Regulation– Prohibition– Positive Discrimination– Redistribution of

Income

Government Intervention}