Externalities. Information Failure Unstable Markets

Transcription

1 Market Failures A market failure ccurs when the quantity f a prduct demanded by cnsumers des nt equate t the quantity supplied by suppliers There exists anther cnceivable utcme where a market participant may be made better-ff withut making smene else wrse-ff The market may nt always allcate scarce resurces efficiently in a way that achieves the highest ttal scial welfare. Scial welfare is the ttal well-being f the entire sciety. Scial welfare is nt measurable because it invlves bth bjective and value judgments. It is nt the same as standard f living but is mre like quality f life that includes factrs such as the quality f the envirnment (air, sil, water), level f crime, extent f drug abuse, availability f essential scial services, as well as religius and spiritual aspects f life. Why markets fail Individual actins have side effects nt taken int accunt by the market (externalities). One party prevents mutually beneficial trades frm ccurring in the attempt t capture a greater share f resurces fr itself. Sme gds cannt be efficiently managed by markets. Mnply Pwer Missing Markets Incmplete Markets Externalities Externalities Infrmatin Failure Unstable Markets Inequality In ecnmics, an externality is a cst r benefit frm an ecnmic transactin that parties external t the transactin receive r incur. An externality refers t the uncmpensated impact f ne persn s actins n the well-being f a bystander. An externality arises when a persn engages in an activity that influences the well-being f a bystander and yet neither pays nr receives any cmpensatin fr that effect. Externalities can be either psitive r negative, and they can be generated frm bth the prductin and the cnsumptin side f a transactin. Negative Externalities When the impact n the bystander is adverse, the externality is called a negative externality. Negative externalities lead markets t prduce a larger quantity than is scially desirable. Any frm f negative externality results in an ver allcatin f the gd r service assciated with the externality. Sciety is prducing t much f a bad thing. Gvernment might wish t discurage prductin r cnsumptin f the gd r service thrugh the use f excise taxes, surtaxes, r tariffs (either n the gd/service r input materials related t their prductin). Page 1 f 5

2 Psitive Externalities When the impact n the bystander is beneficial, the externality is called a psitive externality. Psitive externalities lead markets t prduce a smaller quantity than is scially desirable. A technlgy spillver is a type f psitive externality that exists when a firm s innvatin r design nt nly benefits the firm, but enters sciety s pl f technlgical knwledge and benefits sciety as a whle. Any frm f psitive externality results in an under allcatin f the gd r service assciated with the externality. Sciety is nt prducing enugh f a gd thing. Gvernment might wish t encurage prductin r cnsumptin f the gd r service thrugh the use f subsidies, grants, and tax credits. Private Slutins t Externalities Mral cdes and scial sanctins Charitable rganizatins Integrating different types f businesses Cntracting between parties Case Therem Accrding t the Case therem, even in the presence f externalities an ecnmy can always reach an efficient slutin prvided that the transactin csts the csts t individuals f making a deal are sufficiently lw. The csts f making a deal are knwn as transactin csts. The implicatin f Case s analysis is that externalities need nt lead t inefficiency because individuals have an incentive t find a way t make mutually beneficial deals that lead them t take externalities int accunt when making decisins. When individuals d take externalities int accunt, ecnmists say that they internalize the externality. Why can t individuals always internalize externalities? Transactin csts prevent individuals frm making efficient deals. Examples f transactin csts include the fllwing: The csts f cmmunicatin amng the interested parties csts that may be very high if many peple are invlved. The csts f making legally binding agreements that may be high if ding s requires the emplyment f expensive legal services. Cstly delays invlved in bargaining even if there is a ptentially beneficial deal, bth sides may hld ut in an effrt t extract mre favrable terms, leading t increased effrt and frgne utility. Page 2 f 5

3 Public Plicy Tward Externalities When externalities are significant and private slutins are nt fund, gvernment may attempt t slve the prblem thrugh... cmmand-and-cntrl plicies. Usually take the frm f regulatins Frbid certain behavirs. Require certain behavirs. Examples: Requirements that all students be immunized. Stipulatins n pllutin emissin levels market-based plicies: Gvernment uses taxes and subsidies t align private incentives with scial efficiency. Pigvian taxes are taxes enacted t crrect the effects f a negative externality. Tradable pllutin permits allw the vluntary transfer f the right t pllute frm ne firm t anther. A market fr these permits will eventually develp. A firm that can reduce pllutin at a lw cst may prefer t sell its permit t a firm that can reduce pllutin nly at a high cst. The Ecnmics f Pllutin Pllutin is a bad thing. Yet mst pllutin is a side effect f activities that prvide us with gd things. Pllutin is a side effect f useful activities, s the ptimal quantity f pllutin isn t zer. Then, hw much pllutin shuld a sciety have? What are the csts and benefits f pllutin? Left t itself, a market ecnmy will typically generate t much pllutin because plluters have n incentive t take int accunt the csts they impse n thers. Csts and Benefits f Pllutin The marginal scial cst f pllutin is the additinal cst impsed n sciety as a whle by an additinal unit f pllutin. The marginal scial benefit f pllutin is the additinal gain t sciety as a whle frm an additinal unit f pllutin. The scially ptimal quantity f pllutin is the quantity f pllutin that sciety wuld chse if all the csts and benefits f pllutin were fully accunted fr. Left t itself, a market ecnmy will typically generate t much pllutin because plluters have n incentive t take int accunt the csts they impse n thers Plicies Tward Pllutin Envirnmental standards are rules that prtect the envirnment by specifying actins by prducers and cnsumers. Generally such standards are inefficient because they are inflexible. An emissins tax is a tax that depends n the amunt f pllutin a firm prduces. Tradable emissins permits are licenses t emit limited quantities f pllutants that can be bught and sld by plluters. Taxes designed t reduce external csts are knwn as Piguvian taxes. Page 3 f 5

4 Types f Gds Characteristics f Gds Gds can be classified accrding t tw attributes: whether they are excludable whether they are rival in cnsumptin A gd is excludable if the supplier f that gd can prevent peple wh d nt pay frm cnsuming it. A gd is rival in cnsumptin if the same unit f the gd cannt be cnsumed by mre than ne persn at the same time. A gd that is bth excludable and rival in cnsumptin is a private gd. When a gd is nnexcludable, the supplier cannt prevent cnsumptin by peple wh d nt pay fr it. A gd is nnrival in cnsumptin if mre than ne persn can cnsume the same unit f the gd at the same time. There are fur types f gds: Private gds, which are excludable and rival in cnsumptin, like wheat Public gds, which are nnexcludable and nnrival in cnsumptin, like a public sewer system Cmmn resurces, which are nnexcludable but rival in cnsumptin, like clean water in a river Natural mnplies, artificially scarce gds, which are excludable but nnrival in cnsumptin, like payper-view mvies n cable TV Gds that are bth excludable and rival in cnsumptin are private gds. Excludable? Yes N Yes Private Gds Ice-cream cnes Clthing Cngested tll rads Cmmn Resurces Fish in the cean The envirnment Cngested nntll rads Rival? N Natural Mnplies Fire prtectin Cable TV Uncngested tll rads Public Gds Trnad siren Natinal defense Uncngested nntll rads Why the Market Prduces Private Gds Private gds can be efficiently prduced and cnsumed in a cmpetitive market. Gds that are nnexcludable suffer frm the free-rider prblem: individuals have n incentive t pay fr their wn cnsumptin and instead will take a free ride n anyne wh des pay. When gds are nnrival in cnsumptin, the efficient price fr cnsumptin is zer. If a psitive price is charged t cmpensate prducers fr the cst f prductin, the result is inefficiently lw cnsumptin. Page 4 f 5

5 The Free-Rider Prblem A free-rider is a persn wh receives the benefit f a gd but avids paying fr it. Since peple cannt be excluded frm enjying the benefits f a public gd, individuals may withhld paying fr the gd hping that thers will pay fr it. The free-rider prblem prevents private markets frm supplying public gds. Slving the Free-Rider Prblem The gvernment can decide t prvide the public gd if the ttal benefits exceed the csts. The gvernment can make everyne better ff by prviding the public gd and paying fr it with tax revenue. Cmmn Resurce A cmmn resurce is nnexcludable and rival in cnsumptin: yu can t stp me frm cnsuming the gd, and mre cnsumptin by me means less f the gd available fr yu. Sme examples f cmmn resurces are clean air and water as well as the diversity f animal and plant species n the planet (bidiversity). In each f these cases, the fact that the gd, thugh rival in cnsumptin, is nnexcludable pses a serius prblem. Cmmn resurces left t the free market suffer frm veruse. Overuse ccurs when a user depletes the amunt f the cmmn resurce available t thers but des nt take this cst int accunt when deciding hw much t use the cmmn resurce. In the case f a cmmn resurce, the marginal scial cst f my use f that resurce is higher than my individual marginal cst r the cst t me f using an additinal unit f the gd. T ensure efficient use f a cmmn resurce, sciety must find a way f getting individual users f the resurce t take int accunt the csts they impse n ther users. Like negative externalities, a cmmn resurce can be efficiently managed by: a tax r a regulatin impsed n the use f the cmmn resurce. making it excludable and assigning prperty rights t it. creating a system f tradable licenses fr the right t use the cmmn resurce. Tragedy f the Cmmns The Tragedy f the Cmmns is a parable that illustrates why cmmn resurces get used mre than is desirable frm the standpint f sciety as a whle. Cmmn resurces tend t be used excessively when individuals are nt charged fr their usage. This is similar t a negative externality. Artificially Scarce Gds An artificially scarce gd is excludable but nnrival in cnsumptin. Because the gd is nnrival in cnsumptin, the efficient price t cnsumers is zer. Hwever, because it is excludable, sellers charge a psitive price, which leads t inefficiently lw cnsumptin. A gd is made artificially scarce because prducers charge a psitive price. The marginal cst f allwing ne mre persn t cnsume the gd is zer. The prblems f artificially scarce gds are similar t thse psed by a natural mnply. Page 5 f 5