Market Failure

• Definition:
• Where the market mechanism fails to allocate
resources efficiently
– Social efficiency
– Allocative Efficiency
– Technical Efficiency
– Productive Efficiency
Market Failure
 Social Efficiency = where external costs and
benefits are accounted for
 Allocative Efficiency = where society
produces goods and services at minimum
cost that are wanted by consumers
 Technical Efficiency = production of goods
and services using the minimum amount of
resources
 Productive Efficiency = production of
goods and services at lowest factor cost
Market Failure
 Allocative efficiency:
Also referred to as
 Pareto Efficient Allocation – resources
cannot be readjusted to make one consumer
better off without making another worse off
– zero opportunity cost!
After Vilfredo Pareto (1848 – 1923)
Market Failure
 Market Failure occurs where:
Knowledge is not perfect - ignorance
Goods are differentiated
Resource immobility
Market power
Services/goods would or could not be provided
in sufficient quantity by the market
Existence of external costs and benefits
Inequality exists
Market Failure
 Imperfect Knowledge:
Consumers do not have adequate technical
knowledge
Advertising can mislead or mis-inform
Producers unaware of all opportunities
Producers cannot accurately measure
productivity
Decisions often based on past experience rather
than future knowledge
 Market Failure
• Goods/Services are differentiated
– Branding
– Designer labels - they cost three
times as much but are they three
times the quality?
– Technology – lack of
understanding of the impact
– Labelling and product
information

Which one is the ‘quality’ item and why?

Market Failure
 Resource Immobility
Factors are not fully mobile
Labour immobility – geographical and
occupational
Capital immobility – what else can we use the
Johor Causeway (Tambak Johor) for?
Land – cannot be moved to where it might be
needed – e.g. Bukit Antarabangsa and Sintok!
Market Failure: Market Power:
Existence of monopolies and oligopolies
Collusion - an agreement among firms to divide the market, set
prices, or limit production
Price fixing – agreement among sellers to increase price to
boosts profit
Abnormal profits – excess profit skept hide to reduce the
chance of competition, or government intervention
Rigging of markets - An illegal act or practice in which a
person or company causes a price to be more favorable to an
investor than market forces really justify
Barriers to entry - protect incumbent firms from competition
from newcomers – able to strengthen firm’s price power
 Market Failure
• Inadequate Provision:
• Merit Goods and Public Goods
– Merit Goods – Could be provided by the
market but consumers may not be able to
afford or feel the need to purchase –
market would not provide them in the
quantities society needs
– Sports facilities?
 Market Failure
• Merit Goods
• Education
• nurseries, schools,
colleges,
universities – could
all be provided by
the market but
would everyone be
able to afford them? Schools: Would you pay if the
state did not provide them?
 An Estimation of Education Cost for a Bachelor’s Degree
Programme in Arts & Business (per year) in Various Countries
Country Tuition Fees Living Cost Total Cost

Australia (public) USD 8,500 USD 8,500 USD 17,000

Canada (public) USD 7,500 USD 9,000 USD 16,500

France (public) minimal USD13,000 USD 13,000

Malaysia (private) USD4,600 USD4,000 USD9,000

New Zealand (public) USD 10,000 USD 11,500 USD 21,500

Singapore (private) USD 6,500 USD 10,000 USD 16,500

United Kingdom (public) USD 14,000 USD 12,500 USD 26,500

USA (public) USD 13,000 USD 12,000 USD 25,000

USA (private) USD 22,000 USD 13,000 USD 35,000

Source: Study in Malaysia Handbook (International Edition) & various related websites
 Market Failure
• Public Goods
• Markets would not provide such goods
and services at all!
• Non- excludability
• Person paying for the benefit cannot
A non- excludable good?
prevent anyone else from also
benefiting - the ‘free rider’ problem
• Non- rivalry
• Large external benefits relative to cost
– socially desirable but not profitable
to supply!
• consumption of the good by one individual does not
reduce availability of the good for consumption by Would you pay for this?
others
Excludability
 a good or service is said to be
excludable when it is possible to
prevent people who have not paid for it
from having access to it, and non-
excludable when it is not possible to do
so.
Rivalry
 Rival goods are goods whose
consumption by one consumer prevents
simultaneous consumption by other
consumers.
 Non-rival goods may be consumed by
one consumer without preventing
simultaneous consumption by others.
 Excludable Non-excludable

Common goods (Common-

Private goods
pool resources)
Rivalry food, clothing, cars, personal
fish stocks, timber, coal,
electronics
national health service

Club goods Public goods

Non-rivalry cinemas, private parks, free-to-air television, air,
satellite television national defense
 Market Failure
• De-Merit Goods
• Goods which society over-produces
• Goods and services provided by the
market which are not in our best
interests! – unhealthy, degrading and
negative effects.
–Tobacco and alcohol
–Drugs
–Gambling
–Prostitution
–Junk Food
 Market Failure
• External Costs and Benefits
• External or social costs (negative)
–The cost of an economic decision
to a third party
• External benefits (positive)
–The benefits to a third party as a
result of a decision by another
party
 Market Failure
• External Costs
• Decision makers do not take
into account the cost
imposed on society and
others as a result of their
decision
– e.g. Pollution, traffic
congestion,
environmental
degradation, depletion of
the ozone layer, misuse
of alcohol, tobacco, anti-
social behaviour, drug
abuse, poor housing
 Market Failure
• External benefits –
– by products of
production and decision
making that raise the
welfare of a third party
– e.g. Education and
training, public transport,
health education and
preventative medicine,
refuse collection,
investment in housing
maintenance, law and
order.
 Market Failure
• Inequality:
– Poverty – Absolute and Relative
– Distribution of factor ownership
– Distribution of Income
– Wealth Distribution
– Discrimination
– Housing
Market Failure
 Measures to Correct
Market Failure

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– State Provision
– Extension of property
rights Government
– Taxation Intervention
– Subsidies
– Regulation
– Prohibition
– Positive Discrimination
– Redistribution of Income