# IB Economics/Microeconomics/Market Failure
### 2.4 Market Failure

When the price mechanism fails to take into account all the costs and/or benefits in providing and/or consuming the good, the market will fail to supply the socially optimal amount
   * The competitive forces of supply and demand will not produce quantities of goods where the prices reflect the marginal benefit (utility) of consumption - this in turn leads to over-/under consumption of the good, i.e. allocative inefficiency

#### Reasons for market failure

Most markets are NOT successful, and the government intervenes to some degree
   * Perfect markets are socially efficient, they are operating at Pareto optimality in which no one can be made better off with someone being made worse off (zero sum)
      * Consumer surplus is maximized
      * P=MC where MSC=MSB
   * In the real world, markets are not perfect; MSC does not equal MSB and market failure occurs
   * This is because of externalities, underprovision of merit goods, the overprovision of demerit goods, a lack of public goods, and imperfect markets
   * If the free market is left to its own devices, Pareto market failure will occur
   * Inefficient Producers: producers do not produce where the average costs are at minimum
   * Therefore they are using more resources than they need to
   * Positive and Negative externalities: an externality is an effect on a third party which is caused by the consumption and/or production of a good or service
   * There are four types of externalities
* Positive Consumption Externality
* Negative Consumption Externality
* Negative Production Externality
   * Short-term and long-term environmental concerns, with reference to sustainable development
   * Lack of public goods : public goods are goods which total cost of production does not increase with the number of consumers
Public goods are: 1. non-rivalrous (consumption by one consumer will not reduce the amount available for other consumers in the market, i.e. they do not have to compete to obtain the good/service) 2. non-excludable (no consumer is excluded from consuming such good/service)
      * The classic example is national defence
      * Other examples: street lights, roads
   * Public goods will not be provided by the market
   * Underprovision of merit goods: if left to its own devices, merit goods (a private good that society considers underconsumed, often with positive externalities) will be underprovided
      * These are goods and services which have a positive effect on society like education, healthcare and sports centers
   * Overprovision of demerit goods: if left to its own devices, demerit goods (a private good that society considers overconsumed, often with negative externalities) will be overprovided
      * These are such things as prostitution, alcohol and cigarettes
      * To discourage these demerit goods the government creates: negative advertising, tax on the good, or bans it altogether
   * Abuse of monopoly power: imperfect markets such as oligopolies and monopolies restrict output in an attempt to maximize profit
      * Thus, MSB is not equal to MSC / MSC is equal to MR

#### Possible government responses

   * Legislation: antitrust legislation can be brought in an attempt to break monopoly power and collusive oligopolies
      * Legislation to make high school attendance mandatory
      * Ban smoking in restaurants
   * Direct provision of merit and public goods: governments can control the supply of goods that have positive externalities by supplying a high amount of education, public roads, parks, libraries, etc.
   * Taxation: place an excise tax on the sale of tobacco products or alcohol to discourage consumption
      * This will internalize some of the external costs (i.e., smokers will pay for their second hand smoke through the tax)
   * Subsidies: reduce the cost of university education because it has beneficial externalities
      * The price will be reduced to reflect the benefit society attains through the education of individuals
   * Tradable permits: tradable permits are permits allowing a firm to produce a given amount of pollution
      * There is limited supply for how much pollution a firm can produce so if a firm would want to pollute more it has to purchase tradable permits from other firms
      * A Carbon Tax (taxing consumption which causes pollution, such as fossil fuels) achieves the same result
      * In both cases, firms and individuals are motivated to reduce costs by reducing environmental damage
   * Extension of property rights: form of privatization to privatize certain non-private goods
      * e.g., lakes, rivers, beach=> create a market for pollution and charge people if they want to pollute something
   * Advertising to encourage and discourage consumption: by the government to ensure the social optimum level of consumption is being achieved
   * International cooperation among governments: in the case of acid rain, for example international cooperation among governments is necessary in order to reduce its occurrence