In this video covering the A2 specification we will learn about the concept of market
failure.
By the end of this video you will be able to explain why market failure occurs
and identify the various types of market failure.
When does market failure occur?
It occurs anytime the market mechanism leads to a misallocation of resources.
Before we considered efficiency and efficient resource allocations.
Now we need to consider why the market mechanism results in efficient outcomes.
A misallocation occurs when resources are allocated to the goods and services that do
not serve the best interests of society.
Therefore, the market mechanism fails to achieve an outcome in which social welfare is maximised.
This creates market failure.
The cigarette example should be clearer to you as we approach the end of the video.
It’s important to remember that market failure can be complete or partial.
Complete market failure results in missing markets, in which no market exists to provide
a good.
We’ll see what a partial market means in the types of market failure.
Next we’re going to consider four types of market failure.
By understanding each of these we will have a clearer picture of why markets don’t efficiently
allocate resources every time and start to consider possible solutions.
The first cause of market failure is the under-consumption of merit goods.
This is actually the result of information failure.
I’ll explain why in a moment.
A merit good is a good that is under provided and under consumed in a market.
Since consumers are not aware of their full benefits, they lack the information to consumer
more of it.
This is an example of information failure.
Since the demand is relatively low for such products, they are less likely to be profitable
and therefore under provided.
I’ve put a picture on the right of the introduction of the National Health Service in the UK.
Healthcare can be considered a merit good for multiple reasons.
For now let’s consider the case of vaccinations.
If one individual seeks treatment it benefits the greater society.
Therefore a case can be made for the government to provide such goods.
This stands in contrast to private healthcare providers, as they may have less incentive
to do so due to the profit motive.
The second cause of market failure we’ll consider is the over consumption of demerit
goods.
Demerit goods cause greater harm than the user realises.
This could be both to the individual and other third parties.
This impact on third parties is called an externality, which we will explore shortly
in another video.
Due to a lack of information about the harm of consuming such a good, like cigarettes,
they may be over consumed.
The government may intervene to reduce the amount of cigarettes being consumed in order
to benefit the greater society.
Thirdly, a case can be made for missing markets.
Missing markets may be a problem associated with public goods.
A public good is a good that is non-excludable and non-rival.
Non-excludable means that no one can be excluded from benefiting from it.
Meaning, if someone doesn’t pay tax they can still receive a benefit from the country’s
national defence.
Non-rival means the consumption of one person does not reduce the amount available for someone
else to consume.
This also holds true in the discussion of national defence.
Since there is little to no incentive for producers to supply these goods and services,
they are either not provided or under provided by the market.
Producers also face the free-rider problem in which those who do not pay for a good are
able to enjoy it.
There would be little that could be done to encourage consumers to pay for a good if it
is possible to be a free rider.
Once again, we build a case for government provision of such goods.
Finally, we have to consider markets that lack competition.
Perhaps there is significant market power in the hands of one or a few firms.
In markets where a single firm or a group of firms control the market, prices may be
higher than they would be in more competitive conditions.
Firms would not face competition that would drive them to lower prices.
This lack of competitive pressure could lead to allocative inefficiency.
Additionally, due to the lack of competition, firms do not face the pressure to reduce costs.
This will lead them to produce at higher average costs, resulting in productive inefficiency.
By now you should be able to explain why market failure occurs and identify reasons four types
of market failure.
If you have any questions or comments, leave them below or email me.
Visit my website to dig a bit deeper into these topics and explore some of the growing
library of resources available.
All my contact information is in the video description.
That’s us done for now and I will see you in the next one!