Unit - 9 Investigate the type of intervention of the government to achieve macroeconomic objectives 9.

1 Logically represents the reasons for the market failure o Market failure o Reasons for the market failure Externalities Imperfect competition Imperfect information Non provision of public goods Inefficiency in the provision of quasi-public goods Inefficiency in the provision of merit goods Provision of demerit goods 9.2 Examines the effects of externalities on the market failures o Externalities o Externalities in production Positive externalities Negative Externalities o Externalities in consumption Positive externalities Negative Externalities o Externalities and Market Failures o The meaning correct market failures caused by externalities

9.3 Investigate the role of the government in a market economy o The role of the government in a market economy Efficiency in allocation of resources Equality in distribution of income and wealth Provision of legal framework and governance Macroeconomic stability Economic growth and sustainable development Provision of infrastructure facilities o Government failure

Market Failure
In a perfect world the price mechanism can give us a perfect allocation of resources: what is demanded is produced, changes in demand lead to changes in what is produced, and the workers move from a dying industry to a growing one. But the world is not perfect! Some things stop us getting to this beautiful market solution. It only needs one of these particular elements to be operative, and we will fail to reach the perfect market solution above! And in fact most of them are frequently operative in the real world in which we live! So we know that free markets do not give a perfect answer. However, we have yet to find a better way to get what we want produced: running the whole economy by central planning gives even worse results. So, poor as they may be, free markets are still the best way we have found for organizing the economy. So almost all countries use the market system, then whenever as a society we do not like a particular result that they give, the government can step in and change it.

What does market failure mean?

In any given market, the quantity of a product demanded by consumers does not equate to the quantity supplied by suppliers. This is a direct result of a lack of certain economically ideal factors, which prevents equilibrium. In other words, it means that we do not have full efficiency; we could produce more with the resources we have; and we could satisfy consumer demands better with the resources we have. There is waste in the system.

Types of efficiency in economics:

1. Allocative efficiency. This means good resource allocation, when we cannot make any consumer better off without making some other consumer worse off. This approach looks at the given resources and tries to get the most output from them and it also means that firms sell at a fair price to consumers that reflect the real resource use. 2. Productive efficiency. This means that production is done at the lowest possible cost. This exists when we are actually on the production frontier. That means we are using the least resources we can. In turn, it says that we are at minimum average costs = the bottom of the AC curve. Perfect competition is like this so economists prefer this position and you will recall that it is known as X-efficiency it is where we are totally efficient.

Where market equilibrium is totally efficient, we cannot make someone better off without making someone else worse off

Reasons for the market failure

Different economists have different views about what events are the sources of market failure. Mainstream economic analysis following reasons as the widely accepted market failure reasons: Externalities Imperfect competition Imperfect information Non provision of public goods Inefficiency in the provision of quasi-public goods Inefficiency in the provision of merit goods Provision of demerit goods

1. Externalities An externality means that there is some third, nonparticipating, party to an exchange who is either involuntarily paying a cost or receiving a benefit. This negative externality results in the under-pricing of widgets and means that we will end up making and consuming too many of them. If the externality were positive, prices would tend to be too high resulting in too few of them being consumed and produced. 2. Imperfect competition A type of market that does not operate under the rigid rules of perfect competition. Perfect competition implies an industry or market in which no one supplier can influence prices, barriers to entry and exit are small, all suppliers offer the same goods, there are a large number of suppliers and buyers, and information on pricing and process is readily available. Forms of imperfect competition include monopoly, oligopoly, and monopolistic competition. When firms have market power they tend to cut back production in order to drive up prices and increase profits. This result in too few goods being produced in noncompetitive markets and too many goods being produced in competitive markets. It also means that income is concentrated in the hands of those who have market power at the expense of those who do not. 3. Imperfect information
Misunderstanding the true costs or benefits of a product: E.g. the social costs and benefits of different classes of drugs and the private and social benefits from higher education when there are so many universities and courses to choose from Uncertainty about costs and benefits e.g. should younger workers be buying into pension schemes when we can only guess at economic conditions in 40 years time?

Complex information e.g. choosing between makes of computers requires specialist knowledge of hardware. Do I buy an Apple or PC computer? The problems of choosing a quality second hand car or when deciding whether or not to buy a property Inaccurate or misleading information e.g. persuasive advertising may oversell the benefits of a product leading to a higher demand and consumption than is optimal