Lecture 13. Market Failure (market failure)
Recommended reading : [Microeconomics] Table of contents for Microeconomics
1. Overview
2. Cause 1. Imperfect competition
3. Cause 2. Public goods
4. Cause 3. Externalities
1. Overview
⑴ Market failure : a situation where problems arise in the efficiency of resource allocation and/or the equity of resource distribution
(Efficiency and Equity)
2. Cause 1. Imperfect competition
3. Cause 2. Public goods
⑴ Excludability : the property that people can be prevented from consuming a good
① If a good is non-excludable, people cannot be excluded from consuming it, so it is impossible to charge a fee.
② (Note) Excludability seems related to whether anyone can consume it.
⑵ Rivalry : the property that one person’s consumption restricts another person’s consumption
① If a good is rival, the resources used to produce it are used up with consumption, so the marginal cost of production and the marginal cost of consumption are the same.
② Even if a good is non-rival in consumption, there exists a marginal cost of allowing consumption of one unit of that good.
③ (Note) Rivalry seems related to whether it can be consumed simultaneously.
⑶ Private goods : goods that have both excludability and rivalry
① Examples : ice cream, clothes
⑷ Public goods : goods that have neither excludability nor rivalry
① Generally related to positive externalities
② The economy-wide demand function for a public good is the vertical sum of individual demand functions.
③ Unlike demand for private goods, an individual’s demand for a public good is called virtual demand or pseudo-demand.
④ Examples : typhoon warnings, national defense, neighborhood parks
⑤ The free-rider problem : a problem caused by non-excludability
○ Thinking they can enjoy the benefit without paying, the market will not produce enough if left alone.
○ The government addresses the shortage of public goods by collecting taxes and producing public goods.
○ (Note) Common resources are also non-excludable, but common resources are usually not “produced,” so they are not typically the target of the free-rider problem.
⑸ Common resources : goods that are non-excludable but rival
① Generally related to negative externalities
② Example : the environment
③ The tragedy of the commons (the tragedy of the commons) : the overuse problem
○ Because everyone can use a common resource, no one tries to conserve it, so it soon becomes depleted.
○ (Note) Everyone can use it → non-excludability. It must be conserved → rivalry.
○ Granting property rights to the commons can solve the tragedy of the commons (Coase theorem) (see below).
⑹ Artificially scarce goods : goods that are excludable but non-rival
Figure 1. Artificially scarce goods]
① Supply is intentionally reduced to maintain a high price.
② The average cost curve declines: similar to a natural monopoly.
③ Examples : password-protected WiFi, pay-per-view cable TV
⑺ Club goods (club goods, artificially scarce goods)
① Definition : goods that are non-rival up to a certain level, but become rival beyond that point
② Example : toll expressways
4. Cause 3. Externalities (externality)
⑴ Overview
① Definition : a phenomenon where one person’s action affects the economic welfare of a third party, and no compensation is made for it
② Negative externality : an externality that lowers a third party’s economic welfare
○ Case 1. Change in cost curves : contrast between the private marginal cost curve (PMC) and the social marginal cost curve (SMC) (typical)
Figure 2. Negative externality in the aluminum market
○ Case 2. Change in demand curves : contrast between the private marginal benefit/value curve (PMB) and the social marginal benefit/value curve (SMB)
○ Conclusion : overproduction; a price lower than the socially optimal level
○ Also called an external diseconomy of consumption
③ Positive externality : an externality that benefits a third party
○ Case 1. Change in cost curves : contrast between PMC and SMC
○ Case 2. Change in demand curves : contrast between PMB and SMB (typical)
○ Conclusion : underproduction; a price higher than the socially optimal level
○ Also called an external economy of consumption
④ Conditions for an externality
○ It must be unintended.
○ It must not pass through the market price mechanism.
⑵ Public policies for externalities
① Direct regulation (command-and-control; CAC) : command-and-control policy
○ Advantage : the regulatory effect can be directly ensured
○ Disadvantage 1. The exact degree of regulation cannot be determined; i.e., it may impose unnecessary burdens on firms and reduce consumer benefits.
○ Disadvantage 2. Due to inefficiencies such as administrative audit costs, the cost becomes very large.
○ Example 1. Environmental standards : setting the maximum allowable emission level of pollutants
○ Environmental standards require all factories to reduce emissions below a certain number.
○ Example 2. Mandating the use of purification equipment to reduce emissions
○ Example 3. Requiring adoption of production technology with lower pollutant emissions
② Indirect regulation : market-based policies
○ Internalizing an externality : a process of changing incentives so that people take into account the externalities they cause in decision-making
○ A feature is that all firms have the same marginal benefit level.
○ Advantage : efficiency is high because regulated parties make rational choices
○ Disadvantage : the effect cannot be directly ensured, and punishment is weak
○ Example 1. Corrective taxes : taxes designed to reduce external costs; also called a Pigouvian tax
○ Example 2. Pigouvian subsidies : compensation designed to encourage actions that generate external benefits
○ Example 3. Tradable emissions permits : licenses that allow pollutant emissions; permits can be traded among polluters
⑶ Coase theorem (Coase theorem)
① The principle that inefficiency caused by externalities can be resolved by the market itself
○ That is, internalizing negative externalities through the assignment of property rights
② Assumptions
○ Private economic agents can negotiate without incurring any costs in the resource allocation process.
○ Property rights are clearly defined, regardless of who holds them.
○ (Note) If all stakeholders negotiate, all interests are considered, so externalities are believed to be taken into account.
③ Case 1. When the firm has the right to the river
○ The firm increases pollution emissions up to the point where it can compensate for damages caused by the river.
④ Case 2. When the victims have the right to the river
○ If damages are large, victims pay the firm subsidies not to emit, thereby reducing pollution emissions.
⑤ Limitations
○ Existence of transaction costs
○ Negotiations may easily break down due to imperfect information.
○ If there are many negotiating parties, it is difficult to achieve an efficient bargaining outcome.
⑷ Network externality (network externality)
① When the value of a good to an individual becomes greater as many other people also use that good
② Examples : communication methods, railway networks, hub-and-spoke airline networks, SNS
Entered: 2020.11.28 01:40