Transcript AGEC/FNR 406 LECTURE 3 Tomatoes for sale in a rural Indonesian market.

AGEC/FNR 406
LECTURE 3
Tomatoes for sale in a rural Indonesian market
Markets and market failure
Lecture Goals:
1. Introduce concept of “market failure”
2. Identify key reasons why markets
sometimes fail to achieve socially
optimal outcomes.
What is a market?
A place where BUYERS and SELLERS come
together to express…
…willingness to purchase goods
… willingness to sell goods
This process of EXCHANGE leads to the
identification of economic value.
Categories of economic value
• Consumptive use
• Non-consumptive use
• Existence value
• Option value
Some values apply to stocks, some to flows!
Resource allocation
• The central problem in economics is
how best to allocate scarce resources among
competing uses.
• The logic of scarcity says using resources will
add value to the economy.
• Efficiency requires benefits (goods) to be
balanced with costs (bads).
Market Failure
• Markets tend to work well when allocating
most goods. But when it comes to
allocating natural resources or
environmental goods, they often fail.
• “Market failure” is a term that economists
use to describe situations in which private
valuation and social valuation diverge.
reading
Why do markets fail?
1. Externalities
2. Public goods
3. Imperfect information
4. Inappropriate government intervention
5. Imperfect competition
Failure #1: Externalities
An externality is an unintended side-effect
of production or consumption.
An externality may be either beneficial or
harmful. In either case, the market price
does not reflect the spillover impact.
An example is pollution, as when damages
associated with a production process are not
included in the market price of the good.
Failure #2: Public goods
A public good is nonrival and nonexcludable
in consumption.
My enjoyment does not detract from your
enjoyment, and once provided, access to the
good cannot be restricted.
Incentives for private provision of public
goods are low, and they tend to be
underprovided by the market.
0
Degree of nonrivalry 100%
Public vs. private goods
Concert
•
•
0
•
Global
climate
•
Fish in a lake
Lunch
Degree of nonexcludability
100%
Failure #3: Imperfect information
Imperfect information describes the
situation in which firms or consumers are
unaware of the impacts of their actions.
It does not include cases in which agents
deliberately ignore information.
Examples include health risks due to
exposure to toxic substances, or global
environmental effects of human activity.
Failure #4: Gov’t intervention
If the government intervenes in a market in
a way that affects the market price and
moves it away from the socially efficient
price, then the outcome is a market failure.
An example cited in the textbook is that of
roads provided by the US Forest Service,
which may reduce the cost of timber
extraction for private timber companies who
lease public land.
Failure #5: Imperfect competition
Under imperfect competition the market
price does not reflect the true value of a
good to society.
This is the case because of firm behavior.
The most frequently cited case is a
monopoly (a single producer) that restricts
output in order to raise the price.