GCE(A-level) ECONOMIC B Theme 1 - MARKET FAILURE

Externalities                                                                                                                    

The spillover effects which influence to someone else, 3rd party.

Positive externalities

These are very acceptable. These occurs when there is some satisfaction for third party.

Negative externalities

These are regarded as being desirable because it make external cost which influence the third party negatively.

The strengths of the market economy                     

1. Profit signaling mechanism leads to an efficient allocation of resources
2. The allocation of resources reflects both consumers’ choice and production costs.
3. Competition is generally good for us because it falls down costs and increase efficiency.

The weakness of the market economy                        

1. Negative externalities create spillover effects and these are not reflected in the price of the product.
2. There is over-production and over-consumption of the products.
3. Some market does not have competition which reduces standard of living.
4. The price mechanism sheds no light on income distribution because the use of resource is dominated by the rich 

The purpose of intervention                                                                                                               

Government intervention is designed to correct market failures by:

Reducing the impact of external costs such as pollution

l  Ensuring that under-produced products are available to all

l  Ensuring that over-produced products are discouraged

l  Reducing the impact of anti-competitive businesses’ behaviour so that price are fair to the consumer.

Government use some policies to achieve above points.

Regulation and legislation

Harmful products can be banned by law to protect society.

Passing new laws to restrict activities that create negative externalities and over-consumption. It helps to reduce external cost but it makes cost of implement.

Prohibition also create potential criminal profits which cause government failure

Indirect taxation

Free market price signals can be modified by indirect taxes.

Indirect taxes help to deter some buyers and raise tax revenue.

However, it may be ineffective if price has little impact on

demand. Also, it makes poor people harder.

Grants and subsidies

It encourages to more produce under-consumed products and increase consumption. The government can control some negative externalities by creating an incentive or disincentive that change consumer or producer behavior and reduce external costs.

Nevertheless, it can be costly and they have an opportunity costs such as providing better public service.

If government fails to correct market failure, there will be government failure 

Causes of government failure                      

l  Government do not always have enough information to make good decisions. Some solutions have unintended consequences. These are hard to predict.

l  Some government departments that are responsible for implementing policies may not work sufficiently

l  Distortion of price signals can be a problem. Since price mechanism in market economy sheds no light on income distribution so supply can be focused on demand of few people.