Markets fail to

Allocate resources efficiently

Provide goods to benefit

society

Stop production and consumption of harmful goods

Causes of

Market Failure

Public, Merit and Demerit Goods

Income Distributio

n

Externalities

Abuse of Market Power

Information Failure

Lack of Competitio

n

Government Intervention

Seeks to ensure: • All can benefit, • Efficient functioning of markets• Desirable market outcomes• Better allocation of resources, • Fairer distribution of income• Greater economic stability

However: Too much government intervention – limits innovation, efficiency and growth

Too little – leave consumers exposed to instability, inequality and lack of basic community facilities

Why does the government provide goods and services?

• It needs to satisfy consumer needs e.g.: ABC television and radio in the country areas

• It needs to provide what private sector cannot provide or will not provide. Private sector will only provide if it can make a profit

• Infrastructure, the government will need to provide basic infrastructure such as roads, railways, parks, water supply, bridges, broadband internet etc.to allow the economy to grow and develop.

What are public goods?

• A good which once provided is difficult to prevent anyone from using, regardless of whether they pay for its use.

• For this reason private sector is unwilling to produce and supply these goods – cannot deliver an efficient quantity of these goods

EXAMPLES?

What are the two characteristics of public

goods?

• Non-rivalry (non-diminishability)– Consumption of the good by one person does not decrease the consumption of the good by another person

• Non-excludability – people are not excluded from benefiting from the good or service – attracting ? – who benefit without contributing towards their costs

Merit Goods• Markets sometimes produce an inadequate

quantity of an item e.g. healthcare and art

• The problem is that if they are provided solely by the private sector then they tend to be under-consumed so, again, the government has to step in to correct the market failure

• Merit goods are provided by the government either directly – operating most hospitals or indirectly – through providing financial support for arts

• The best two examples are healthcare and education. Both of these goods can be provided privately and publicly

• Merit goods are public goods which benefit the community, not just individuals. Often it is a public good provided on merit meaning the government (usually) provides for the needy in the community,

e.g.: discounts on medicine for pensioners ($5.80 max price in 2012),

housing for the needy, free education for all, free healthcare for all etc.

• The concept of a merit good was introduced in economics by Richard Musgrave (1957, 1959) and is a commodity which an individual or society should have on the basis of some concept of need, rather than ability and willingness to pay

• Merit goods are things that are good for you.

• There are also demerit goods and these are goods that are harmful to individuals and communities

• The government imposes restrictions on the production and sale of these goods

Research Task

What restrictions has the government imposed on the production and sale of demerit goods?

In groups of two or three search 1 policy, advertisement or campaign which the government has come up with in an attempt to stop or limit the production and sale of demerit goods

My examples• Australia’s plain

packaging legislation is crucial both because it will help prevent children from starting to smoke and encourage adults to quit, and because the domino theory is nowhere more evident than in tobacco control

http://youtu.be/gUsB8AQtLOE

• Governments sometimes provide goods by operating as a monopoly

• A natural monopoly – is a market structure in which goods can only be efficiently provided by one supplier

• It occurs where it would be inefficient for competition to operate. If the government did not maintain ownership of these monopolies, then private owners would have the exclusive control leaving consumers no choice but to pay whatever price for their good or service.

• The government tries to set a fair price that ensures that consumers pay for cost of providing the good or service but are not exploited by extreme prices

Key features1. No close substitutesThe good has no close substitutes – no competitione.g. Water board – no substitute for showering or washing cars – only other option is staying dirty!!

2. Barriers to entryLegal or natural constraints that protect a firm from potential competitorsE.g. of legal constraints – law, patent or licence restricting competition by preventing entryE.g. of natural constraints – firm can supply an entire market at a lower price than one or two firms can

Market failure in the abuse of market power

• It is difficult for small firms to survive in the market given the costs of production, distribution, marketing etc. possibly creating a market structure where there is imperfect competition (oligopoly, monopoly, monopolistically competitive)

• Businesses in highly concentrated industries have considerable market power and abuse it in these ways: Monopolisation Price discrimination Exclusive dealing Collusion and market sharing

• Monopolisation – a firm which uses its powerful market position to eliminate existing competition or stop new firms from entering the marketo E.g.

• Price discrimination – charging a higher price to some customers than to others for an identical product o E.g.

Also occurs when an individual customer is charged a higher price on a small purchase than on a large one

• Exclusive dealing – When a business sets conditions for supply excluding other retailers from dealing with competitors

• Collusion and market sharing – occurs when two or more producers get together and agree:o to restrict output o on a priceo on market sharing o on levels of output

in order to raise prices and profitsIt is illegal in AustraliaCartel – group of firms entered into a collusive agreement

What is another cause of market failure which is not a result of the

operation within individual markets?

Market Instability• Market failure can occur across the economy

• The boom-bust behaviour of activity in the economy in the business cycle can create considerable economic problems

• In a free-market severe fluctuations in the economy can lead to numerous problems:o Boom – o Recession –

• Governments intervene to sustain economic growth through macroeconomic policies such as ? and microeconomic policies such as?