AS Level Economics – Revision

Market Failure: Other market failures

1. Public goods
2. Failures in the labour market
3. Concentration of power in markets
4. Information failure

1.  Public goods

Definition: Public goods share two defining characteristics:

1. Non-excludable: once the good has been produced for the benefit of one person, it is impossible to stop others from benefiting from it.
2. Non-rivalrous: as more people consume the good and enjoy its benefits, the benefits to those already consuming the good are not reduced.

Examples: defence, street-lighting, lighthouses

Nature of the problem: public goods may not be produced at all in the free market even though people place a positive value upon them and would, in principle at least, be willing to pay for them. Thus scarce resources should be, but fail to be, allocated to producing them. The free-market mechanism fails. The root of the problem is the possibility of free-riding.

Solutions to the problem: government provision funded by taxation; legally binding licensing schemes; voluntary/cooperative schemes

Example questions:

1. Explain why public goods are unlikely to be supplied in the free market. {4k&a)
2. Discuss the effectiveness of taxation as a way of financing national defence {6 k&a, 2 ev}

2.  Failures in the labour market

Nature of the problem: free markets can lead to significant, and possibly problematic, inequalities of income and wealth in society.

Sources of the problem:

1. Supply and demand

Many argue that to allow the interaction between supply and demand to determine the price of labour leads to unacceptable unfairness. There is a moral dimension that the free market fails to consider. It is immoral to allow free market forces to determine the price of labour in the same way in which they determine the price of a Snickers bar. (Remember the distinction between positive and normative economics here.)

2. Labour market imperfections

• occupational immobility of labour
• geographical immobility of labour
• unequal bargaining power between employers & employees

Solutions to the problem:

• minimum wage
• progressive taxation
• provision of education and training opportunities
• housing policy
• regional policy
• labour market regulation (e.g. legal right to trade union representation)

Example questions:

1. Explain why an increase in the minimum wage might have different effects on businesses in different sectors of the economy and in different regions of the country {6 k & a}
2. Examine the case for and against increasing the level of the minimum wage. {6 k & a, 4 ev}

3.  Concentration of power in markets

Nature of the problem:

Lack of perfect competition and the existence of monopoly power can lead to a loss of productive efficiency and allocative efficiency…

• Productive efficiency: Everything that is produced must be done so using the least possible amount of scarce resources. The lowest possible resource cost must be involved with every aspect of production.

• Allocative efficiency: The right amount of the right products must be produced. The cost of producing goods and services should be in line with the amount of satisfaction or utility they give.

Monopolies, because they can earn super-normal profits, may tend not to achieve productive efficiency. They can get away with inefficiencies which would make firms in competitive markets go out of business.

Monopolies also tend to restrict output in order to increase the price of their products – there is therefore under-production and allocative inefficiency.

Sources of the problem:

1. Economies of scale (the gains in efficiency (fall in unit costs) from expanding the scale of production)

• technical economies (specialist and expensive capital, division of labour, law of increased dimensions)
• marketing economies
• purchasing economies
• financial economies
• managerial economies

2.   Barriers to entry

• Patents and other legal barriers
• customer loyalty
• high set-up costs and “sunk costs”
• economies of scale

Solutions to the problem:

Industrial regulation: 

• Office of Fair Trading (OFT): investigates allegations of anti-competitive practices such as collusion and price-fixing. Also investigates mergers and takeovers which will lead to market share of 25% or more or if the target company has a turnover of £70 million or more.

• Competition Commission: carries out in-depth inquiries into competition and mergers cases referred to it by the OFT.

• European Commission: investigates anti-competitive practices and mergers at EU level.

• Utility regulators: monitor and regulate firms in industries such as water, electricity, gas, and telecommunications. Regulars can impose price and quality of service controls. Examples: OFWAT, OFGEM, OFCOM.

Example questions:

1. Explain two possible barriers to the entry of new firms to the supermarket industry. {6 k&a}
2. Evaluate the case for and against the Competition Commission imposing constraints upon the further growth of the major supermarket chains. {6 k&a, 4 ev}

4.  Information failure

Nature of the problem: where there is imperfect information, markets are likely to fail. Key example: merit and de-merit goods…

• Merit good: a merit good is a product that is better for a person than that person realises. Examples: education, dentistry, broccoli.
• De-merit good: a de-merit good is a product that is worse for a person than that person realises. Examples: alcohol, salt, turkey-twizzlers.

Merit goods will tend to be under-produced and consumed, whereas de-merit goods will tend to be over-produced and consumed.

Most merit goods will also have associated positive externalities and most de-merit goods will have associated negative externalities (e.g. benefits/costs to the NHS).

Draw a diagram to illustrate undersupply of merit goods (below)

Diagrammatic illustration of the problem:

 

 

 

 

 

 

 

 

 

Solutions to the problem:

• Information & advertising campaigns
• Taxes & subsidies
• “Free” provision
• Legal regulation & prohibition

Example questions:

1. (Analyse the case for and against the government banning fizzy drinks and turkey-twizzlers from schools. {6 k & a, 2 ev}
2. Assess any two options open to the government to encourage greater consumption of fresh fruit and vegetables. {6 k & a, 4 ev}