2023 ACJC H2 Market Failure Lecture Notes

©ACJC Econs Dept/2023/H2 Market Failure 1 ANGLO-CHINESE JUNIOR COLLEGE JC1 Economics H2 MARKET FAILURE AND GOVERNMENT INTERVENTION Section Content Page 1 Efficiency in Markets 4 2 Sources of Market Failure and Government Intervention 7 2.1 Public Goods 8 2.2 Externalities 11 2.2.1 Overview to Externalities 12 2.2.2 - 2.2.3 Negative Externalities 15 2.2.4 - 2.2.5 Positive Externalities 26 2.3 Information Failure 35 2.3.1 – 2.3.2 Insufficient and Inaccurate Information 35 2.3.3 Asymmetric Information 41 2.4 Factor Immobility 48 2.5 Market Dominance 53 3 Equity in Relation to Markets 57 3.1 Understanding the concept of Equity 57 3.2 Government Intervention to address Inequity 58 4 Decision Making by the Government 60 4.1 Summary of Government Policies 60 4.2 Government Failure 61 Learning Reflection and Annex 63

©ACJC Econs Dept/2023/H2 Market Failure 2 WHAT IS THIS TOPIC ABOUT?  Due to the central economic problem of scarcity, resources need to be allocated in ways that bring about the most efficient outcome.  In the free market, the price mechanism is the primary means by which resources are allocated and this would bring about efficiency in resource allocation.  However, these conditions must be present for price mechanism to bring about efficiency: o There are price signals to ‘direct’ resource allocation. o No third-party effects (externalities) in consumption or production o The market is perfectly competitive. o Perfect information in the market. o Perfect factor mobility.  When any of these conditions is not met, resource allocation becomes inefficient (market failure). Examples of the market failure: o Missing market for public goods. o Under or over-consumption/production due to externalities. o Underproduction due to market dominance (H2 only). o Collapse of market or under/over consumption/production due to information failure. o Inefficiencies due to factor immobility.  Due to these market failures, the government has to step in to correct them in order to achieve an efficient and equitable allocatio n of resources.  However, due to several constraints and factors, the government might fail. Its interventions may cause even greater inefficiency in resource allocation than under the workings of free market forces. LEARNING OUTCOMES Enduring Understanding (students can explain and apply to real world):  Price mechanism can fail to allocate resources efficiently and equitably. NOTE: Inequity is a distributional issue and not considered a source of market failure.  Government has to make decisions on how to intervene in markets to correct market failure in order to achieve efficient and equitable allocation of resources.  However, even with government intervention, the intended outcomes may not be achievable due to constraints in policy implementation, uncertainty of policy effects, and unintended consequ