market failure diagrams&definitions

Market Failure

Diagrams and Definitions

What is market failure?

At times markets fail to

allocate resources efficiently

provide goods beneficial to

society

stop production and consumption of harmful goods

Sources of Market Failure

ExternalitiesMerit and Demerit Goods

Public GoodsAbuse of

Monopoly Power

Positive Externalities

Third parties benefit from the production

of goods and services

Third parties benefit from the

consumption of goods and services

Negative Externalities

Third parties bear spillover costs of the production of goods

and services

Third parties bear spillover cost of the

consumption of goods and services

Negative Production Externality

Negative Consumption Externality

Tax and Negative Production Externality

Tax on Producers and Negative Consumption Externality

Advertising to Shift Demand and Reduce Negative Consumption Externality

Correcting Negative

Externalities of Production

Legislation &

Regulation

Tradable PermitsTax

Correcting Negative

Externalities of

Consumption

Legislation &

Regulation

AdvertisingTax firm

Positive Production Externality

Positive Consumption Externality

Correcting Positive

Externalities of

Consumption

Legislation

AdvertisingSubsidies

Correcting Positive Externalities of

Production

Subsidy

Extension of Property Rights

to Correct Negative

Externalities

Internalize Externality

Market-based Appeal

Offending Firms and third parties

monitor progress

Public, Merit & Demerit Goods

Public Goods

• Non-Excludable• Non-rivalrous• Free riders

Merit Goods

• Merit goods are under-consumed and underprovided

Demerit Goods

• Demerit goods are overconsumed and overprovided

• Positive externalities• Lack of income • Lack of knowledge

Merit Goods

• subsidies• government provision• advertising• regulation

Solutions

• Negative externality

• Lack of knowledge and/or apathy

Demerit Goods

• tax• advertising• regulation

Solutions

• inefficiencies • higher prices

Monopoly Power

• legislation and regulation

• government ownership

Solutions