A.S 3.3A.S 3.3

Describe and illustrate Describe and illustrate resource allocation via the resource allocation via the public sector to compensate public sector to compensate market failuremarket failure

Why does the government Why does the government intervene?intervene?

The free market is not always able to achieve allocative efficiency. – Market Failure

An allocative efficient point is where

All resources are allocated to their most efficient use

All markets are in equilibrium

The economy is operating on its production possibility curve.

It is not possible to make someone better off without making someone else worse off (Society’s well being is maximised)

This situation is also called Pareto efficiency We will be looking at situations where it is possible to make someone better off without making someone else worse off.

This is when governments intervene in the market.

Conditions for the market to Conditions for the market to achieve allocative efficiencyachieve allocative efficiency Requires clear price signalsRequires clear price signals

There must be There must be Perfect CompetitionPerfect Competition Perfect InformationPerfect Information Perfect MobilityPerfect Mobility Consumer Sovereignty Consumer Sovereignty No Externalities or public goodsNo Externalities or public goods

Reading Price SignalsReading Price Signals

Market FailureMarket Failure

Market Failure can occur from any Market Failure can occur from any of the following of the following

The existence of imperfect market The existence of imperfect market structuresstructures

ExternalitiesExternalities Public GoodsPublic Goods Merit and Demerit goodsMerit and Demerit goods Situations where the market leads to Situations where the market leads to

inequitable (unfair) outcomesinequitable (unfair) outcomes

Market FailureMarket Failure Markets can fail in a number of waysMarkets can fail in a number of ways

Some products may be under produced or not produced at all. ie parks

Some products may be produced or over produced but are not wanted by society

ie drugs

The production and consumption of some

products affect third parties. ie pollution and smoking cigarettes.

The distribution of market income may not enable all citizens to participate meaningfully in society

Market FailureMarket Failure Market failure provides governments Market failure provides governments

with the reason to intervene in the with the reason to intervene in the economy or in particular markets economy or in particular markets that are failing.that are failing.

Government intervention aims to Government intervention aims to overcome the failure of markets to overcome the failure of markets to move towards a more allocatively move towards a more allocatively efficient position efficient position

Establish Property

Rights

Subsidies

Transfer Payments

Education and social

marketing campaigns

Regulation

Public Provision

Taxation

Types of Government Intervention

Government InterventionGovernment Intervention Four functions of the governmentFour functions of the government

1. Legislative/Regulator Role1. Legislative/Regulator Role• Legal FrameworkLegal Framework

• Providing a framework so buyers and sellers know their Providing a framework so buyers and sellers know their rights and obligations – enables fair dealing. Legal rights and obligations – enables fair dealing. Legal system used to clarify, define and enforce property system used to clarify, define and enforce property rights. rights.

• Promoting CompetitionPromoting Competition• Commerce Commission. Commerce Commission.

• Correcting for externalities Correcting for externalities

Government InterventionGovernment Intervention

2. Allocative Role2. Allocative RoleGovernments allocate resources that the market Governments allocate resources that the market

fails to produce in sufficient quantitiesfails to produce in sufficient quantities

3. Distributive Role3. Distributive RoleGovernments aim to promote equity (fairness) Governments aim to promote equity (fairness)

This may be done through redistribution of This may be done through redistribution of incomesincomes

4. Stabilisation Role4. Stabilisation RoleGovernment aims to provide a stable economic Government aims to provide a stable economic

environmentenvironment

Indicate which Government Indicate which Government Function is being done when…. Function is being done when….

cuts taxes to reduce unemployment specifies that a manufacturer is liable for any harm

caused by its product places a tax on a steel producer’s pollution legislates that it is illegal to discriminate on the basis

of gender, ethnicity or sexual orientation imposes a wage/price freeze provides funding for a job search scheme provides benefits for low income families provides childcare funding to allow women to work legislates to prevent misleading advertising prevents large companies from merging

Range of Government InterventionsRange of Government InterventionsMethodMethod Effect/ what it isEffect/ what it is Best for:Best for:

SubsidySubsidy

Sales TaxSales Tax

Income Tax Income Tax

RegulationsRegulations

Transfer Transfer PaymentsPayments

Public Public Ownership/Ownership/

ProvisionProvision

Lowers the cost of production

Lowering the price to encourage the production and use of certain products. More resources are allocated to a good/service than would be provided by the free market.

Increases the cost of production

Raises the price to discourage the production and use of certain products. Pay for some of the costs imposed on society as a result of the product being consumed

Reduces Incomes Reduces demand. Progressive taxation narrows the gap between rich and poor and reduces inequality of income

More direct effect than taxes or subsidies

Limit or prohibit the production or consumption of certain products. Enforce the production or consumption of certain products

Redistribution of incomes from “rich to poor”

Addressing income inequality in form of social welfare benefits and income support.

Situations where its not socially desirable for provision to be in private ownership. Providing G&S not sufficiently provided by the free market

Army, Police

Libraries, parks, Rubbish collection, Education

ExternalitiesExternalitiesThe are two parties in the marketThe are two parties in the market• Producers and ConsumerProducers and Consumer

• Externalities are costs or benefits that Externalities are costs or benefits that affect those other than the consumer affect those other than the consumer or producer (the third party)or producer (the third party)

• These costs or benefits are not taken These costs or benefits are not taken into account in the costs of production into account in the costs of production or consumption. or consumption.

• Externalities are also known as Externalities are also known as “Spillovers” as the cost or benefit “Spillovers” as the cost or benefit spills over from the producer or the spills over from the producer or the consumerconsumer

Negative Externalities of ProductionNegative Externalities of Production

Costs that are imposed on third Costs that are imposed on third parties as a result of productive parties as a result of productive activityactivity

The well being of third party is reduced – The well being of third party is reduced – this is the costthis is the cost

These costs to third parties are not taken These costs to third parties are not taken into account by producers and therefore no into account by producers and therefore no compensation is paidcompensation is paid

Too much of these goods will be produced.Too much of these goods will be produced.

The Effect of Externalities- Negative The Effect of Externalities- Negative Externalities of productionExternalities of production

MSC The social costs of production are greater than the private costs of production

The free market will under price and over produce the good when compared with the socially desirable price and output.

Pollution

Positive Externalities of ProductionPositive Externalities of Production

Benefits that are gained by third parties as Benefits that are gained by third parties as result of productive activitiesresult of productive activities

The well being of the third party is The well being of the third party is increased- this is the benefitincreased- this is the benefit

Producers are not able to charge for the Producers are not able to charge for the benefits but third parties can still enjoy benefits but third parties can still enjoy benefits for freebenefits for free

As a result too little of these goods will be As a result too little of these goods will be produced. produced.

The Effect of Externalities- Positive The Effect of Externalities- Positive Externalities of ProductionExternalities of Production

MSC

•The social costs of production are less than the private costs of production

•The free market will over price and under produce the good when compared with the socially desirable price and output

•Tree Planting

Negative Externalities of Negative Externalities of ConsumptionConsumption

Costs imposed on third parties as a result Costs imposed on third parties as a result of consumptionof consumption

These costs are avoidable by consumers These costs are avoidable by consumers but do not directly affect the consumerbut do not directly affect the consumer

These costs are not taken into These costs are not taken into consideration by the consumer in the consideration by the consumer in the decision making processdecision making process

Too much of these types of goods will be Too much of these types of goods will be consumedconsumed

Can u think of some examples of negative Can u think of some examples of negative consumption externalities?consumption externalities?

The Effect of Externalities- Negative The Effect of Externalities- Negative Externalities of ConsumptionExternalities of Consumption

MSB

•The social benefits of consumption are less than the private benefits of production

•The free market will under price and over produce the good when compared with the socially desirable price and output level

•Smoking

Positive Externalities of Positive Externalities of ConsumptionConsumption

Benefits gained by third parties as a result of consumption

Benefits that consumers create but Benefits that consumers create but have no way of being compensated have no way of being compensated for by those who benefit at no costfor by those who benefit at no cost

Too less of these goods will be Too less of these goods will be consumed as all the benefits of consumed as all the benefits of consumption are not taken into consumption are not taken into account in decision making processaccount in decision making process

The Effect of Externalities- Positive The Effect of Externalities- Positive Externalities of ConsumptionExternalities of Consumption

SMB

•Social benefits of consumption are greater than the private benefits of consumption

•The free market will over price and under produce the good when compared with the socially desirable price and output level

•Using public transport

Externalities Externalities

Can u think of some examples of Can u think of some examples of negative production and negative production and consumption externalities?consumption externalities?

Can u think of some examples of Can u think of some examples of positive production and consumption positive production and consumption externalities?externalities?

The effect of externalitiesThe effect of externalities

What effects our decision making What effects our decision making process?process?

Producers decisions are based on Producers decisions are based on their Marginal coststheir Marginal costs

Consumers benefit from Consumers benefit from consumption and their decisions are consumption and their decisions are based on their Marginal benefits. based on their Marginal benefits.

When externalities are present the When externalities are present the true costs or benefits to society may true costs or benefits to society may not be reflected in individual MB and not be reflected in individual MB and MC curves. MC curves.

Types of Goods

Private Goods Mixed Goods Public Goods

Natural MonopoliesNatural Monopolies

Free Rider ProblemFree Rider Problem

Merit GoodsMerit Goods

Demerit GoodsDemerit Goods

Measures to improve Measures to improve equityequity