SAJC 2023 JC1 H2 Market Failure 2 Lecture Notes

Market Failure and Government Intervention II © St Andrew’s Junior College Page 1 Economics Department ST ANDREW’S JUNIOR COLLEGE JC 1 H2 ECONOMICS 2023 Market Failure and Government Intervention (Part 2) In the previous topic, Firms and Decisions - Market Structures, we have learnt that the characteristics of the different types of market structure determine a firm’s behaviour or conduct. This behaviour in turn affects the firm’s performance. You may have observed the negative impacts that firms exhibit because of their market power. In this topic, we will learn how the following market imperfections cause markets to fail: • Factor Immobility; and • Information Failure Market failure provides the justification for government i ntervention in the free market. The decision-making process with the government as the main focal point can thus be used as an approach to gain a better appreciation of the complexities of decision- making at the governmental level. Learning about market failure will deepen our understanding of the complexities in the real world, equip us with the tools to analyse how the real world works and predict the impact that decisions have on firms, industries and the nation. We will be equipped as informed citizens to critically examine the impact of market operations from multiple perspectives and recommend checks for public interest.

Market Failure and Government Intervention II © St Andrew’s Junior College Page 2 Economics Department MARKET FAILURE AND GOVERNMENT INTERVENTION 1. MARKET FAILURE AND GOVERNMENT INTERVENTION IN THE MARKET ............................ 5 1.1 Immobility of Factors of Production .................................................................................................... 6 1.1.1 Government Intervention to Deal with Immobility of Factors of Production .................................................. 8 1.2 Information Failure ................................................................................................................................ 10 1.2.1 Imperfect Information in Imperfect Competition ...................................................................................................... 10 1.2.2 Asymmetric Information ....................................................................................................................................................... 10 2. APPENDIX ................................ ................................ ................................ ................................ ................. 26 2.1 Appendix 1: Medishield Life ....................................................................................................................... 26 2.2 Appendix 2: More about the 3Ms .............................................................................................................. 27 2.3 Appendix 3: Singapore’s CareShield Life ................................................................................................ 28 2.4 Appendix 4: Singapore’s Lemon Law ....................................................................................................... 29 Reading List and Reference 1. Akerlof (1970), The Market for Lemons: Quality Uncertainty and the Market Mechanism, Quaterly Journal of Economics 84, Pages 488 -500 2. Nyman (2004), Is Moral Hazard Inefficient? The Policy Implications of A New Theory, Health Affairs Sept 2004, Vol 23, Pages 194 - 199

Market Failure and Government Intervention II © St Andrew’s Junior College Page 3 Economics Department Learning Objectives By the end of this series of lectures and tutorials, you should be able to: Efficiency in relation to markets: ▪ Understand that market efficiency is achieved when allocative efficiency is attained. Market Failure and its causes ▪ Understand that markets may no t operate ideally and may fail due to market imperfections. ▪ Explain the meaning of market failure and the possible causes of market failure, in particular those arising from information failure and factor immobility. ▪ Understand that factor immobility is a constraint experienced by producers when making production decisions and that this can cause markets to fail. ▪ Explain occupational and geographical immobility and the reasons behind these types of factor immobility, ▪ Understand that information failure and the concept of asymmetric information, in the form of moral hazard and adverse selection, can result in market failure. ▪ Illustrate information failure and the concept of asymmetric information through the use of real-world examples. Government intervention in markets ▪ Explain why governments intervene in the markets to correct market failures. ▪ Examine and evaluate the various methods by which governments intervene in markets. ▪ Explain how governments make decisions in real -world contexts and would take into account non-economic considerations, such as policy acceptability, as well. Concepts and Tools of Analysis ▪ Market Failure ▪ Allocative Efficiency ▪ Deadweight Loss ▪ Factor Immobility ▪ Information Failure: - Imperfect Information - Asymmetric Information: Moral Hazard, Adverse Selection

Market Failure and Government Intervention II © St Andrew’s Junior College Page 4 Economics Department Free market allocates resources via price mechanism Price mechanism fails to allocate resources efficiently when there exist sources of market failure Sources of Market Failure Presence of Externalities Presence of information failure (imperfect information) Market dominance (This will be covered in Firms & Decisions) Misallocation of resources caused by the sources of market failure and inequity, are reasons why governments intervene in the market through the use of appropriate policies. Taxes and subsidies Tradable permits Rules and regulations Ban Direct provision of goods & services Government measures to correct market failure and/or lack of equity Effective and appropriate measures may fully or partially correct the market failure and/or inequity but inappropriate intervention may lead to government failure. Knowledge of cognitive bias can increase effectiveness of policies. Non- provision of public goods Public Education Price mechanism results in efficient resource allocation BUT may not result in equitable outcomes. Inequalities in the distribution of income and wealth Asymmetric Information Factor Immobility (These will be covered in Market Failure Pt 2) CONCEPT MAP ON MARKET FAILURE AND INEQUITY

Market Failure and Government Intervention II © St Andrew’s Junior College Page 5 Economics Department 1. MARKET FAILURE AND GOVERNMENT INTERVENTION IN THE MARKET Recall : What is market failure? Definition: Market failure is a situation in which the market does not provide the right mix of goods or optimal amount of a particular good. As a result, the market is not allocating resources efficiently and society’s welfare is not maximised. Left to the free working of the price mechanism and assuming that the economy is a perfectly competitive market with no externalities, the resulting equilibrium in the economy will be economic efficient. Adam Smith stressed that the “invisible hand” leads people with self -interest to act in such a way that promotes overall welfare for the economy. However, in reality, the market economy does not always achieve optimum allocation of resources due to the following sources of distortions that lead to market failure. Market Failure can arise from the following causes: • Non-provision of public goods; • Presence of externalities in the consumption or production of goods and services; • Under-consumption of merit goods and over -consumption of demerit goods; • Market dominance; • Immobility of factors of