Market Failure

• Adverse outcome: supply and demand fail to achieve balance \(\implies\) Inefficient distribution
• Theory \(\implies\) two forces balance ideally \(\implies\) production will match demand, prices rise and fall to maintain equilibrium
  • Balance disrupted in market failure.
• Complete (no market exists) vs partial (market exists wrong quantity/wrong price)

How?

• Inefficient distribution \(\implies\) individuals end up worse off than not acting in rational self-interest (it's that bad!)
• Overall group \(\to\) too many costs, too few benefits

• Economic outcomes deviate from optimal

• Market failures in government activity

  • rent-seeking by special interest groups
  • each small group imposes costs

• Correcting the imbalance

  • Government intervention
  • Private-market actors
• Not all market failures have a potential solution

Causes (EICPG)

Remember as Externalities Inform Control to Public Goods

Many types of imbalances

1. Externalities
   • Consumption or service harms a third part
   • Pollution from production
   • Negative externalities \(\implies\) Collateral damage \(\implies\) market failure
2. Information Failure
   • Partial information
   • Buyer/seller lacks info on which price is based \(\implies\) overpay or undercharge
3. Market control
   • One party with too much control \(\implies\) imbalanced pricing
   • Monopoly/Oligopoly (single or small group) manipulate pricing
   • Monopsony/Oligopsony buyers have advantage
4. Public goods
   • Defy the tenets of supply and demand
   • Nonexcludable: everyone has access, consumption cannot be limited only to those paying for it
   • Nonrival: use by one individual doesn't limit consumption by others
   • Private sector has less incentive to produce public goods \(\implies\) Govt has to produce or subsidize their production

Solutions

• Private Market Solutions
  • A solution may emerge from the private market itself
  • e.g. Asymmetrical Information (Securities)
    • Intermediaries/Rating agencies: Moody's and Standard & Poor's
    • inform market participants about security risk
  • e.g. Asymmetrical Information (Electronics)
    • Underwriters Laboratories LLC
  • e.g. Negative Externalities (Pollution)
    • Tort Lawsuits to increase opportunity costs for polluter
  • e.g. Public Goods (Non-excludability)
    • Radio broadcast elegantly solve non-excludable problem
    • Package paid ads with the free broadcast (so someone is paying)
• Government-imposed Solutions
  • No solution from market \(\implies\) Government enters
  • e.g. Business hire too few low-skilled workers after min wage increase
    • government creates exceptions for less-skilled workers
  • Impose tax and subsidies
    • Subsidies encourage behavior \(\implies\) positive externalities
    • Taxation cut down negative behavior \(\implies\) e.g. tax on tobacco \(\implies\) increased cost of consumption \(\implies\) more expensive to smoke \(\implies\) Smoking is harder (discouraged)
• Collective action solutions
  • Parties privately
    • agree to limit consumption
    • enforce rules among themselves
    • to overcome tragedy of the commons (= Social or political problem where each individual in incentivized to act in such a way that will ultimately be harmful to all individuals¹)
  • Consumers and producers
    • form co-ops to provide services that would be underprovided in a pure market
    • e.g. Electric service to rural homes
    • e.g. Cooperatively held refrigerated storage facility for groups of dairy farmers to chill their milk at an efficient scale

      Recurring theme: Disrupted balance of supply and demand

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1. for personal gain, people deplete shared (common) resources. Exploitation, underinvestment and eventually depletion, e.g. extinction of dodo bird ↩