Lecture 21
MARKET FAILURE
1. Definition
Market failure occurs when the price system fails to yield the
socially optimal quantity of a good.
1.1 Role of government
What is the appropriate degree of government intervention in the case of a market failure?
2. Imperfect competition
- Price does not equal marginal cost
- Govt regulation of monopolies
3. Externalities
(a) Negative externality
- Social cost exceeds private cost
- Marginal social cost (MSC) is greater than MPC
- Govt policy:
- Market-oriented approach to contain pollution
(b) Positive externality
- Social benefit exceeds private benefit
- Society's demand lies to the right of private demand
- Govt policy: Provide a subsidy
4. Public Goods
(a) Not depleted by additional consumption
- A dam is built to prevent flooding
- Viewing a TV program
- National defense
- A movie theater that is not very crowded
(b) Impossible to exclude people from consuming the good
- Difficult to collect fees
- Free rider problem
5. Imperfect information
- Consumers may be unaware of quality of goods
- Govt may require "truth-in-advertising"
- Is government intervention necessary?
5.1 Moral hazard
- Insurance protects against risk
- But also encourages the insured to take risks
5.2 Adverse selection
- Only sick people will buy health insurance