Correcting Market Failure
UNDERSTAND WHAT IS MEANT BY MARKET
FAILURE.
UNDERSTAND THAT PRODUCTION AND
CONSUMPTION CAN LEAD TO NEGATIVE
EXTERNALITIES.
EVALUATE POLICIES TO CORRECT MARKET
FAILURE
Market Failure
 When the market (through demand and supply) fails
to allocate resources in the best interests of society as
a whole.
 Supply & Demand Diagram
Graph
 By looking at the graph we can see that at £4 there is
equilibrium. However, although at equilibrium, we
have to ask if the market is failing.
 At prices of cigarettes of £4.00 does not include the
externalities (days of work, sick, rubbish). Therefore
we should say that there should be £1.00 tax to cover
this, thus increasing the price to £5.00. By doing this
we would see a contraction in demand.
 In this instance, where the cigarettes are £4.00, we
can say that the market has failed.
 It has not taken into account the externalities.
 In summary the market has not allocated its
resources in the best possible way.
Economic Question
 The one point we need to consider in economics is
the best way that scarce resources should be
allocated.
 By doing this we must consider ‘How much
government intervention there should be?’
 What would happen if the markets were left alone?
 Invisible glove??
 Can be broken down into
 Free market
 Shared
 Communist ( total control)
Provision of merit goods
 What is a merit good?
 What do you think would happen to the
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consumption of a merit good in a market economy?
We say it would be under consumed.
Example:
Using previous graph, the market is left to itself and
so education is charged at £4000.00.
What would happen? In this instance we need to
look at the graph from a private point of view.
 In this instance people would look at the cost and
see what the benefits are of paying for education.
 Some would say that benefits are able to learn,
behaviour, organisation, time keeping……but what is
not being taking into account?
 The social benefits.
 People will look at education from a personal point
of view and how it benefits them.
 So once again in this aspect the price of £4000, does
not take into account social benefits. You could say
that with the external benefits that education is
worth an extra £1000 taking it to £5000.
 Further some just wouldn’t pay for education.
 Thus we say that the market is under consumed
 In this case the government has to get involved due
to the external benefits. The government takes
control, education is free, as there are so many
benefits. This is an example of how a free market
might never work.
Demerit Goods
 With demerit goods the opposite is true.
 We see that it is over consumed.
 At £4, the price does not take into account negative
externalities. Thus the product, cigarettes, is over
consumed.
 £1 should go and pay for the external costs (and in
reality tax does far outweigh these)