Market Failures

1. Market Failures Frederick University 2008

2. Questions What and how much How For Whom Problems Efficiency in allocation Efficiency in motivation Efficiency in distribution Main Economic problems

3. Market Functions Achieve: • Efficiency in allocation • Efficiency in motivation • Efficiency in distribution

4. Market failures Market failures are all cases when • markets fail to perform their functions - functional market failures, or • markets perform their functions, but the outcomes do not fit the system of social values - social market failures

5. Public goods I won’t use it and I am not gonna pay for it! Public Goods – goods, which are nonrival and nonexcludable in consumption

7. Externalities What about our rivers? A chemical company would like to build a plant here We’ll make them any color you want

8. Externalities Externalities – cases where social costs and benefits differ from private costs and benefits Social cost D P S – private cost ps p1 qs Q q1

9. Merit goods P S P3 Merit goods – goods, whose utility consumers tend to underestimate subsidy D P1 p2 q2 Q q1

10. Demerit goods Demerit goods – goods whose utility consumers tend to overestimate P D p2 S tax p1 q2 Q q1

11. Asymmetric Information Racing? Let me just get my car insurance!!!

12. Incomplete Markets • Bounded rationality • Moral hazard and adverse selection

13. Monopoly vs. Pure Monopoly • Monopoly – an ability to produce a good or a service that others are not able or allowed to. • Pure monopoly – a market structure, determined by only one producer of a good with no close substitutes

14. Natural Monopoly • Natural monopoly – a monopoly position, determined by factors, which cannot be replicated • Types of natural monopoly: • Monopoly, created by a possession of resources, inaccessible to competitors • Monopoly, justified by economies of scale • Local monopoly

15. AC Economies of Scale AC P Q

16. Institutional Monopoly • Institutional monopoly – a monopoly, deliberately created by economic decision makers • Types of institutional monopoly: • Monopoly, created by a collusion, or a merger • Monopoly, created by institutional barriers to entry to the industry • Government monopoly

17. Monopoly Pricing P MC D P AC Q Qm MR

18. MC AC AR =D MR Pure Monopoly and Perfect competition Consumer surplus = ∑ (P –MWP) Under perfect competition=KLN Under pure monopoly=NRT L P N Producer surplus= ∑ (P-MC) Under pure monopoly the producer surplus rises byKGTR at the expense of the consumer surplus R T Pm GTL – the portion of the consumer surplus, which is a deadweight loss for the society JGL – the portion of the producer surplus, which is a deadweight loss for the society Pp.c. K G J Qp.c. O Qm Q TLJ – total deadweight loss for the society

19. Instability Unstable macroeconomic equilibrium, creating cyclical fluctuations in employment and price level

20. The Role of Government Musgrave’s Three Branches • stabilization • allocation • distribution

21. The government failure Of course you may register a complaint about all the government paperwork, sir, ... But it has to be in writing.