Market Failure 1.4
IB Syllabus Requirements:
The meaning of market failure: Market failure as a failure to allocate resources efficiently
• Analyse the concept of market failure as a failure of the market to achieve allocative efficiency, resulting in an over-allocation of resources (over-provision of a good) or an under-allocation of resources (under-provision of a good).
Types of market failure:
The meaning of externalities:
• Describe the concepts of marginal private benefits (MPB), marginal social benefits (MSB), marginal private costs (MPC) and marginal social costs (MSC).
• Describe the meaning of externalities as the failure of the market to achieve a social optimum where MSB = MSC.
Negative externalities of production and consumption
• Explain, using diagrams and examples, the concepts of negative externalities of production and consumption, and the welfare
loss associated with the production or consumption of a good or service.
• Explain that demerit goods are goods whose consumption creates external costs.
• Evaluate, using diagrams, the use of policy responses, including market-based policies (taxation and tradable permits), and government
regulations, to the problem of negative externalities of production and consumption.
Positive externalities of production and consumption
• Explain, using diagrams and examples, the concepts of positive externalities of production and consumption, and the welfare loss associated with the production or consumption of a good or service.
• Explain that merit goods are goods whose consumption creates external benefits.
• Evaluate, using diagrams, the use of government responses, including subsidies, legislation, advertising to influence behaviour, and
direct provision of goods and services.
Lack of public goods
• Using the concepts of rivalry and excludability, and providing examples, distinguish between public goods (non-rivalrous and non-
excludable) and private goods (rivalrous and excludable).
• Explain, with reference to the free rider problem, how the lack of public goods indicates market failure.
• Discuss the implications of the direct provision of public goods by government.
Common access resources and the threat to sustainability
• Describe, using examples, common access resources.
• Describe sustainability.
• Explain that the lack of a pricing mechanism for common access resources means that these goods may be overused/depleted/
degraded as a result of activities of producers and consumers who do not pay for the resources that they use, and that this poses a threat to sustainability.
• Explain, using negative externalities diagrams, that economic activity requiring the use of fossil fuels to satisfy demand poses a threat to
sustainability.
• Explain that the existence of poverty in economically less developed countries creates negative externalities through over-exploitation of land for agriculture, and that this poses a threat to sustainability.
• Evaluate, using diagrams, possible government responses to threats to sustainability, including legislation, carbon taxes, cap and trade schemes, and funding for clean technologies.
• Explain, using examples, that government responses to threats to sustainability are limited by the global nature of the problems and the lack of ownership of common access resources, and that effective responses require international cooperation.
HL Requirements:
Asymmetric Information:
- Explain, using examples, that market failure may occur when one party in an economic transaction (either the buyer or the seller) possesses more information that then other party.
- evaluate possible government responses, including legislation, regulation and provision of information.
Abuse of Monopoly Power:
- Explain how monopoly power can create a welfare loss and is therefore a type of market failure.
- Discuss possible government responses, including legislation, regulation, nationalization and trade liberalization.
Market Failure
Goals for the day: After today you should understand:
1. The meaning of market failure: Market failure as a failure to allocate resources efficiently
• Analyse the concept of market failure as a failure of the market to achieve allocative efficiency, resulting in an over-allocation of resources (over-provision of a good) or an under-allocation of resources (under-provision of a good).
2. Types of market failure: (Externalities; lack of public goods; common access goods and the threat to sustainability)
3.The meaning of externalities:
• Describe the concepts of marginal private benefits (MPB), marginal social benefits (MSB), marginal private costs (MPC) and marginal social costs (MSC).
• Describe the meaning of externalities as the failure of the market to achieve a social optimum where MSB = MSC.
Review:
1. The meaning of market failure: Market failure as a failure to allocate resources efficiently
• Analyse the concept of market failure as a failure of the market to achieve allocative efficiency, resulting in an over-allocation of resources (over-provision of a good) or an under-allocation of resources (under-provision of a good).
2. Types of market failure: Today we focused on externalities and types of goods (public vs private)
The meaning of externalities:
• Describe the concepts of marginal private benefits (MPB), marginal social benefits (MSB), marginal private costs (MPC) and marginal social costs (MSC).
• Describe the meaning of externalities as the failure of the market to achieve a social optimum where MSB = MSC.
Homework: Read pp123-126 and review the videos for extra review:
Part 2: Merit and Demerit Goods
Part 3: Negative Externalities
Goals: By the end of the day you should understand:
Negative externalities of production and consumption
• Explain, using diagrams and examples, the concepts of negative externalities of production and consumption, and the welfare
loss associated with the production or consumption of a good or service.
• Explain that demerit goods are goods whose consumption creates external costs.
• Evaluate, using diagrams, the use of policy responses, including market-based policies (taxation and tradable permits), and government
regulations, to the problem of negative externalities of production and consumption.
Read through the post and answer the corresponding questions
Activity 2: Government Responses to Negative Externalities: Compare and contrast advertising and taxing as a response to negative externalities. Which do you think is more effective and why?
Sugary Drink Tax in Philly:
Pros and Cons of a Carbon Tax:
Other examples:
Airport Expansion Plans” re: negative externalities together in class.
Article on Taxing Negative Externalities: Students to complete “1.4B – The Cutlery Conundrum” re: taxing a negative externality
Find your own example of a negative externality. Prepare to share with the class.
Homework: Read pp126-133 and complete the exercises on P.133
Optional Extra review of how to graph negative externalities of production and consumption
How to graph an Indirect tax to solve a negative externality of consumption (demerit good) and production
And another review of externalities in general
Positive Externalities
Do Now Review: Draw a graph of a negative PRODUCTION externality and label the necessary components of that graph. THEN draw what it would look like if the government imposed a tax on the production of the good causing the negative externality.
Milton Friedman on how to fix Market Failure:
Positive Externalities of Growing diverse crops instead of soy and corn in Iowa
Goals for the day:
• Explain, using diagrams and examples, the concepts of positive externalities of production and consumption, and the welfare loss associated with the production or consumption of a good or service.
• Explain that merit goods are goods whose consumption creates external benefits.
• Evaluate, using diagrams, the use of government responses, including subsidies, legislation, advertising to influence behaviour, and
direct provision of goods and services.
Review Videos
Activity 1:
Group Poster - Get students into groups of 3 – each group to create a poster:
Imagine you 3 are the dictators of a single country – discuss and decide what, if anything, you would do about each of the below:
K-12 education
Corporate personnel training
Birth control
The need for public parks
Childhood immunizations
Now create a poster LABELING the topic, depicting WHAT (if anything) you are going to do and GRAPHING the effect of your policy
Activity 2: Government Responses to Positive Externalities
Students are to create a Venn diagram comparing and contrasting direct provision, advertising, and subsidizing as a response to the problem of positive externalities and write a short paragraph evaluating each policy.
Optional Extra review of positive externalities of production and consumption
The pros and cons of government provision of goods:
Public Goods and Sustainability
Review: What kind of a positive externality does owning tree farm create? Draw a graph to indicate this externality and what type of intervention could be done to correct this externality.
Goals for the Day:
• Using the concepts of rivalry and excludability, and providing examples, distinguish between public goods (non-rivalrous and non-
excludable) and private goods (rivalrous and excludable).
• Explain, with reference to the free rider problem, how the lack of public goods indicates market failure.
• Discuss the implications of the direct provision of public goods by government.
• Describe, using examples, common access resources.
• Describe sustainability.
• Explain that the lack of a pricing mechanism for common access resources means that these goods may be overused/depleted/
degraded as a result of activities of producers and consumers who do not pay for the resources that they use, and that this poses a threat to sustainability.
• Explain, using negative externalities diagrams, that economic activity requiring the use of fossil fuels to satisfy demand poses a threat to
sustainability.
• Explain that the existence of poverty in economically less developed countries creates negative externalities through over-exploitation of land for agriculture, and that this poses a threat to sustainability.
• Evaluate, using diagrams, possible government responses to threats to sustainability, including legislation, carbon taxes, cap and trade schemes, and funding for clean technologies.
• Explain, using examples, that government responses to threats to sustainability are limited by the global nature of the problems and the lack of ownership of common access resources, and that effective responses require international cooperation.
The Tragedy of the Commons:
Rivalrous vs. Excludability/Public vs. Private Goods review
Individual Research: Choose one example of an externality. What could the government do to fix the externality? Would it really benefit society? What is a different solution that could work?
Practice Paper 1:
a. Explain the concept of negative externalities of consumption.
b. Evaluate two policies that may be used by governments to reduce external costs of production.
HL Requirements: Asymmetric Information
- Explain, using examples, that market failure may occur when one party in an economic transaction (either the buyer or the seller) possesses more information that then other party.
- evaluate possible government responses, including legislation, regulation and provision of information.
Abuse of Monopoly Power:
- Explain how monopoly power can create a welfare loss and is therefore a type of market failure.
- Discuss possible government responses, including legislation, regulation, nationalization and trade liberalization.
Potential Paper 1 Questions:
1.
a. The basic economic problem is one of scarcity of productive resources. Explain how resources are allocated between competing uses in a market economy.
b. Discuss the view that there is strong justification for market intervention in the market for health care.
2.
a. Explain why the under provision of merit goods in an economy is considered to be a market failure.
b. Evaluate the possible measures that a government might use to correct such a market failure.
3.
a. Explain the signaling and incentive functions of price in a market economy
b. Evaluate the proposition that government intervention in the market for tobacco is justified.
4.
a. With the aid of a diagram explain how the application of a flat rate tax (a specific/fixed amount) could reduce the amount of pollution produced by a chemical factory.
b. Evaluate the measures that a government might adopt to correct market failure arising from negative externalities.
5.
a. Using an appropriate diagram, explain how negative externalities are a type of market failure
b. Evaluate the measures that a government might adopt to correct market failure arising from negative externalities.
6.
a. Explain the distinction between public goods and merit goods and why these goods are examples of market failure.
b. "The operation of the free market is always the best way to allocate scarce resources." Evaluate this statement.
7.
1.
a. Analyse the consumption externalities which might arise from the provision of education and health care for the citizens of a country.
b. Evaluate the use of government policies to increase the consumption of health care.
Theory of knowledge: potential connections
To what extent is the obligation to seek sustainable modes of consumption a moral one?
What knowledge issues are involved in assessing the role of technology in meeting future patterns
of consumption and decreasing the negative externalities of consumption associated with fossil
fuels?
What are the knowledge issues involved in determining what is a rational cost to pay for halting
climate change?
How could we know if economically more developed countries are morally justified in interfering in
the development of economically less developed countries on the grounds of climate change?
How can we know when climate change is sufficiently serious to warrant government interfering in
the freedom of its citizens to consume?
How can we calculate the external costs of producing and running items such as light bulbs or motor
vehicles? For example, low energy light bulbs consume less energy but they require more energy to
produce, and some brands contain materials that are harmful to the environment such as mercury.
Hybrid cars consume less energy to run but consume more energy to produce.
What are the problems in knowing whether climate change is produced by human activity?
Homework: Find a current event article related to Market Failure