3.1. Problems of Market Failures (1) In reality, no market such a perfectly competitive market....
-
Upload
alexis-ward -
Category
Documents
-
view
222 -
download
2
Transcript of 3.1. Problems of Market Failures (1) In reality, no market such a perfectly competitive market....
3.1. Problems of Market Failures (1)
In reality, no market such a perfectly competitive market. Market tends to be imperfect
Hence, Pareto Efficiency cannot be achieved if rely on market mechanism in allocating resource in the economy
3.1. Problems of Market Failures (2)More over, efficiency in allocation of
resources is not the only concern of people.
People need some other than resource allocation efficiency, such as more equal distribution of income, good condition of environment, elimination of unemployment and popverty
3.1. Problems of Market Failures (3)
All these are beyond market concern. Since, the market only deals with efficiency
Government intervention is required to satisfy these other needs of people
3.1. Problems of Market Failures (4)
In short, if market fails to achieve pareto efficiency and fail to deliver the other needs of people the government has to substitute the role of market to satisfy all these
Market failures government intervention to improve welfare of the society
3.2. Sources of Market FailuresPublic goods Externalities Natural monopoly Imperfect informationMerit goods Income distribution/equalityUnemploymentInflation
3.3. Public Goods (2) Three types public goods:
Excludable, non-rival public good impure public goodsNon-excludable, rival public goods impure public goods Non-excludable, non-rival public good pure public goods
3.3. Public Goods with Excludable, Non-rival Characters (1)Example: Free way Exclusion makes the service marketable Price > 0 even though MC =0 provision by private sector becomes feasible
But, private provision will not be Pareto optimum.
Since, price will be determined not by market mechanism (S and D)
MC = P, MC = 0, hence P = 0
3.3. Public Goods with Excludable, Non-rival Characters (2)
Price must be determined by mechanism other than market mechanism, such as government decision
Consequently, the determined price may be too high or too low
Provision will not be optimumThough not achieve ‘Pareto Efficiency’,
private provision will result in social improvement
3.4. Public Goods with Non-Excludable, Rival Public Characters (1)
Common property resource Example, ocean fishing ground If market mechanism over fishingTragedy of the Common Individual rationality leads to collective
disaster
3.4. Public Goods with Non-Excludable, Rival Public Characters (2)Resource depletion and dissipation of
economic rentEconomic rent incentive for
conservationPareto inefficiencyGovernment intervention is desirable to
improve the condition
3.5.Public Goods with Non-Excludable, Non-Rival Public Characters (1)
Example, lighthouse Collective action to build Free rider as constraint for collective
action to take place If free rider problem is not controlable
lighthouse will not be presentHence, government intervention is
desirable in building the lighthouse
3.5.Public Goods with Non-Excludable, Non-Rival Public Characters (2)However, when ‘ a privilege group’ exists
private provision of the lighthouse is feasible even though free riders are at large
But, the private provision will not be pareto efficiency undersupply
Hence, government intervention is desirable to improve the supply
3.6. Externalities (1)Two types by characters :
Negative e.g. air pollution by manufactures
Positive e.g. fresh air produced by Bogor botanical garden
Two types by sources :Consumption demand curve Production supply curve
Government intervension is desirable
3.7. Positive Externalities: Problem of Under Supply of Goods Generating Positive Externalities
MSB
MPBMPC
Qm Qs
Pm
Ps
Price SociallyOptimum
Note: Qm < Qs
3.8. Negative Externalities: Problem of Over Production of Goods Generating Negative Externalities
MSC
MPC
MB
Price
QmQs
Pm
Ps
Supply Curve
Demand Curve
Socially Optimum
Note: Qm > Qs
3.8. Natural Monopoly (1) Natural Monopoly?
Cost production declines as scale operation increase economies of scale
Cause large total fixed cost Example,
Production electricity Airport service for airline landing and take-off
3.8. Natural Monopoly(2) Large economies of scale production is best by a single big firm If monopoly right is granted to a private
firm, it may not produce the required goods at the lowest cost
Instead, it may produce at level that satisfy MR = MC to earn extra profit
3.8. Natural Monopoly(3) If produced at MR = MC P > MC. Thus,
social loss will prevail Social loss pareto inefficiency Government intervention is required to
correct the condition Government own firms (e.g. PT PLN and PT
Angkasa Pura) But, government own firms often create another
kind of inefficiency problem ?
3.9. Imperfect Information (1)
Facts Information is imperfect Information is costly to acquire
Direct consequence Asymmetric information between market actorsE.g Buyer vs seller, employee vs employer
3.9. Imperfect Information (2) Consequences :
Moral hazard problem Adverse selection problem Missing markets (e.g absence of crop
insurance in Indonesia ) Government intervention is desirable to
improve the condition
3.10. Other Market Failures Market is not concern about all these:
Provision of merit goods Controlling inflation
Poverty alleviationControlling Unemployment Income redistribution
Government intervention is desirable to address and solve them
3.11. Government Failures (1)
Government intervention often fail to make improvement. Instead, it makes even worsened
Example, provision of electricity power by the government controlled monopolizing firm is often criticized of being inefficient
3.11. Government Failures (2)Why government failures occur?
Conflict of interest’Political motivesRent seeking activities