Market Failure LO6 AC6.1 ASSESSMENT CRITERIA AND INDICATIVE CONTENT 2 LO6: Evaluate the effectiveness of economic policies in resolving contemporary economic

Market Failure LO6 AC6.1 ASSESSMENT CRITERIA AND INDICATIVE CONTENT 2 LO6: Evaluate the effectiveness of economic policies in resolving contemporary economic challenges. AC6.1 Explain and analyse the causes and economic implications of market failure, including externalities and information asymmetry. Definition of Market failure and its causes and implication for the economy

Concepts of consumer and producer surplus and deadweight loss using diagrammatical

illustration. Meaning and characteristics of public, quasi-public, merit and demerit goods. Externalities in Consumption and Production in relation to social efficiency using diagrams. Imperfections in the market: Missing information, asymmetric information, adverse selection

and moral hazard. Key Reading for Students:

Smith, P. (2019), OCR A Level Economics, 4th Ed. Hodder

Education, London – Chapters 8 & 9 Market Failure OCR A Level Economics (4th Edition) –

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EBSCO Discovery Service

Merit and Demerit Goods It is a vaccination service It is known as a merit good Merit goods are often services The government thinks that merit goods provide positive benefits

for both the people that use them and society as a whole Why in this case They should be consumed to a greater degree Because the market doesn’t provide enough (because there is not

enough demand) the government has to step in How can it supply more It can provide them directly It can subsidise them so that there is no direct cost to the consumer

Why no direct cost Because they pay indirectly through taxes

Merit goods are products that

society values and judges that

society should have regardless of

whether an individual wants

them – they are under

consumed by society because

the benefits of the good are not

fully appreciated by society Merit goods

More Merit Goods Why is this a merit good If the government didn’t provide schools would everyone pay for it Maybe you would be too poor to afford it and leave your kids at home The market would not provide enough so government has to step in Education and healthcare in

the UK would not be produced

in sufficient quantity by a free

market because consumers

would not want to purchase

enough of these services.

This

is because they may not have

enough knowledge to assess

the true private benefits. Private benefit

– the benefit to

private

businesses or

individuals Why are these Merit Goods Would government

provide or

subsidise these

services to the

same extent Some will be more

important than others and

will gain more funding Merit goods tend to have positive externalities

– that is they have positive benefits to those not

involved in the transaction The social benefits are greater than the private

benefits In the case of the library the benefit to a person

(private benefit) is to become better educated The external benefits are that the economy may

grow because the labour force is better educated

and more efficient The social benefit is both of these put together. Private benefit – the

benefit to private

businesses or

individuals Social benefits = private benefits plus

external benefits External benefit– the benefit to the

third party not

involved Positive externalities It is fast food It is known as a demerit good The government thinks that demerit goods are bad for both the

people that use them and society as a whole Why They should be consumed to a lesser degree Because the market provides too much (there is too much

demand) the government decides to step in How can it reduce supply It could ban them It could educate consumers on the harm Anything else It could put a tax on them How would that work Demerit goods are those

products that society deems as

bad for you

– again a value

judgement is being made Demerit goods

Why are these Demerit Goods If government chose

tax to reduce alcohol

consumption would it

tax the same % as

cigarettes Cigarettes may be

seen as more

harmful than

others and have

higher taxation Information failure: demerit goods Demerit goods are those products that society deems as bad for you

– again a value judgement is

being made Smoking, Drugs, Gambling, foods that make you obese are all examples of demerit goods in

western society A product that the government believes

consumers overvalue because of imperfect

information.

A demerit good is ‘socially undesirable’ and

‘worse’ for a consumer than the consumer

realises e.g. alcohol Government will seek to reduce

consumption of demerit goods Watch this mjmfoodie video Public goods Private goods vs Public goods Private goods are the opposite to public goods so if we understand what they are first

then we will understand what public goods are Businesses in the private sector provide private goods Characteristics of private goods Private goods are excludable – consumers of private goods can be excluded from

consuming the product if they are not willing or able to pay for it

For example – a ticket to the theatre or a sports event or a meal in a restaurant – If

you don’t pay, you don’t consume and benefit from the good or service! Private goods are rival One person’s consumption reduces the amount left for others to consume Scarce resources are used up in producing and supplying the good or service There is an opportunity cost Private goods are rejectable Private goods can be rejected Public goods Pure public goods have three main characteristics: Non-excludability:

The benefits of public goods cannot be confined to

those who have paid for it Non-payers can enjoy the benefits of consumption at

no financial cost to them Non-rivalry in consumption:

Consumption of a public good by one person does not

reduce the availability of a good to others In other words, if the good is provided for one person it

must be provided for others Non-rejectable If a public good is provided, we cannot avoid it

Pure Public Goods Pure public goods are also known as collective consumption goods National Defence Systems

Sewage and Waste Disposal Systems Lighthouse Protection National Rail Safety Systems Street Lighting The market would not provide these so they are called full market

failure or a missing market Why would the market not provide Free riders! The free rider problem If provision of public goods was left to the free market, there would be

complete market failure (none would be provided at all). This is because of their non-excludability – if you cannot be excluded

from the benefit of the good, where is your incentive to pay for the good A free rider is someone who receives the benefit of a good, but does not

pay for it. Their consumption depends on others paying for the good. For example, you may be able to increase your economic welfare by

riding a train without paying for a ticket. The free rider problem In a pure free market economy, national

defence, policing and a judiciary are unlikely

to be provided, because they could not be

sold to benefit individual citizens. They can only be provided by a government

with the power to force citizens to pay taxes

to fund these services. There is no equilibrium point where demand

and supply intersect. Quantity Pr ic e S D For many other public/quasi-public goods, there would be

dramatic underprovision. For example, it may be possible to persuade residents of an

affluent street to pay for streetlights or road maintenance, as it

would be to their benefit. However, residents in other, poorer areas would not be able to

pay the required cost and therefore the good would not be

provided. Which one is the odd one out The benefits of water

filtration systems The enjoyment of a

fireworks display The light for passing

ships Chilling out on the

beach Semi-Public (Quasi) Public Goods These are products that are public in nature, but do not exhibit fully the features of non-excludability and non-rivalry They may become rival e.g. at peak times when congestion occurs On grounds of equity (fairness) the government may provide these

goods directly and finance them through general taxation There is an element of excludability or rivalry in consumption Examples might include: Motorways and major roads Parks Terrestrial television (public service broadcasting) Police Force protection Galleries and Museums Airwaves Why does the state provide public goods Because public goods are non-excludable, profit-seeking firms will not provide

them. The non-excludability of a public good encourages some consumers to avoid

payment and become free riders. Firms cannot collect all the revenue needed to supply the public good and make a

profit.

The state/government provides them On grounds of equity – so that people on all levels of income can have access to

them Provision on grounds of need rather than ability to pay On grounds of efficiency Easier to provide them collectively Economies of scale from providing to all To overcome the free-rider problem To correct for market failure – the failure of the market to provide sufficient

public goods (partial market failure) Mini Review Without looking at your notes tell me… What are the characteristics of public goods

Why would public goods be under-provided or

not provided by the market mechanism What are quasi-public goods Extension: What problems would Governments

face in providing public goods intostudy.com/intomanchester Please attempt the quizzes on the VLE for