Revision and Consolidation

Microeconomics

Market Failure

Market Power

Key sources of market failure

ExternalitiesMerit / Demerit Goods

Public Goods

Market Power

Definition:• The ability of a single (or a small group of)

buyer / seller to have substantial influence on market price

Market Power

Market failure:• Market power in the product market:

given their ability to control prices, firm ____ px ______-consumption (allocative inefficiency)

Market Power

Government intervention:• Price control – AC or MC pricing• Nationalisation• Anti-trust laws / Competition laws

Negative Externalities

Definition:• The consequence of an economic activity that

spills over to affect third parties whereby the costs of the action are not fully borne by the two parties engaged in exchange or by an individual engaging in a scarce-resource-using activity

Negative Externalities

Market failure:• Individuals consider only their private benefits

and costs when making production and consumption decisions, ignoring the external costs of their action

_____-production / ______-consumption

Negative Externalities

Government intervention:• Pigovian taxes; subsidise alternatives• Production quotas; cap and trade

Merit / Demerit Goods

Definition:• Merit goods are goods that have been deemed

socially desirable through the political process

Market failure:• Under-provision (merit goods) / over-provision

(demerit goods) by the private sector

Government intervention:• Merit goods – (1) subsidies, (2) state provision• Demerit goods – (1) taxes, (2) state monopoly

Public Goods

2 key characteristics:• Non-rivalrous• Non-excludable

Market failure:• Free-rider problem non-provision of public

goods by the private sector

Government intervention:• State provision, funded by taxes

ACJC 2006a. Explain why, in the absence of government intervention,

water pollution results in an allocative inefficient outcome. (10)

MSB ≠ MSC

Welfare lossNegative externality

1. Definition

2. Who are those third party affected? How are they affected?

3. Explain the market failure caused by –ve externality

4. Graph to illustrate, highlight:

• Over-production

• Welfare loss

ACJC 2006A Chinese government has closed 52 polluting factories in the Huaihe river basin in order to stop serious water contamination in the region. b. Assess whether shutting down of these factories is the

best way to curb river pollution. (15)

Limitations / ineffectiveness of policy?

Are there undesirable side-effects?

Are alternative policies better?

ACJC 2006b. Assess whether shutting down of these factories is the

best way to curb river pollution. (15)

How does it work? Is it effective?

Eliminates all pollution from the factories

Is it desirable?

While pollution is undesirable, the total elimination is equally undesirable.

In fact, the socially optimum level of output allows for some degree of pollution. (graph)

Negative externality

Quantity

$

Demand = MPB = MSB

Supply = MPC

MSC = MPC + MEC

QPQS

MECS

ACJC 2006b. Assess whether shutting down of these factories is the

best way to curb river pollution. (15)

Why it doesn’t make sense to shut down factories

Pollution abatement clearly benefits society

BUT

Pollution abatement also involves costs

In this instance, shutting down factories denies the society of the goods they produce.

Pollution abatement is beneficial only in so long as the benefits of outweighs the costs.

ACJC 2006b. Assess whether shutting down of these factories is the

best way to curb river pollution. (15)

Consider alternative policies

1. Pigovian tax / emissions fee

2. Tradable permits

Explain how they work to get the pollution down to the socially optimum level.

Comment on their strengths and their limitations

Conclusion

NJC 2006a. Distinguish between merit goods and public

goods and consider under which of these classifications the tsunami predicting system should be placed. (12)

Definition ?Example: educationMerit goods are essentially private goods• Rivalrous• ExcludableUsing the example of education, explain why it is both rivalrous and excludable.

Distinguishing characteristics

Non-rivalrous

Non-excludable

NJC 2006a. Distinguish between merit goods and public

goods and consider under which of these classifications the tsunami predicting system should be placed. (12)

Merit goods are essentially private goods• Rivalrous• Excludable

Implications

Public goods cannot be provided by private sector

Merit goods can still be provided by the private sector, just that …

Distinguishing characteristics• Non-rivalrous• Non-excludable

Note:

Presentation of answers must be in the AB-

AB format

NJC 2006a. Distinguish between merit goods and public

goods and consider under which of these classifications the tsunami predicting system should be placed. (12)

Public Good

Non-rivalrous

Non-excludable

Explain why the tsunami predicting system bears the 2 characteristics

NJC 2006b. Discuss whether government intervention in

dealing with positive externalities leads to an efficient use of resources. (13)

Balanced argument with evaluative comments

Thesis: Why govt intervention may be necessary1. Definition of +ve externality2. Explain the market failure

caused by +ve externality3. Graph to illustrate, highlight:

* under-pdtn / under-cn* welfare loss

Anti-thesis: Problems with govt intervention1. Egs of govt intervention

in dealing with +ve externality2. Problems with govt intervention

NJC 2003‘Right now 5 million people in China have tuberculosis, 10% of people have chronic hepatitis B. Due to the lack of resources and attention, such silent epidemics are simply ignored.’Daniel Chin, a World Health Organisation Official

a. Explain how ‘silent epidemics’ may be viewed as sources of market failure. [12]

Source of mkt failure: negative externality

1. Definition

2. Who are those 3rd party affected? How are they affected?

3. Explain the market failure caused by –ve externality

4. Graph to illustrate, highlight:

(a) Over-production, (b) welfare loss

NJC 2003b. To what extent can the government of China

ensure an optimal allocation of scarce resource in the provision of health services? [13]

Balanced argument with evaluative comments

Thesis: Why govt intervention may be necessary1. Relate to part (a) healthcare can therefore be

seen as a merit good with +ve externalities

2. Graph to illustrate, highlight:(a) under-production, (b) welfare loss

Anti-thesis: Problems with govt intervention1. Egs of govt intervention

in dealing with +ve externality2. Problems with govt intervention