13. Market failures analysis



Contents
nterm „market failure“
nmarket failure as a problem of the system
nfailure of the elements of the system (externalities, public goods, asymetric information)

The term „market failure“
nMarket failure:
nWhatever display of inefficient function of the market
nmarket fails as a system: a natural tendency to the ineffeciency – imperfect competition
nelements of the system fail: - externalities, public goods, asymetric information

The system failure



System failure
nnatural tendency of perfect competition markets to the imperfect competition
nnatural aim of firms to strengthen their market positions
nperfect → imperfect competition

nImperfect competiton is allocative and productive inefficient
nproductive inefficiency – equilibrium output not produced with minimal AC
nallocative inefficiency – existence of DWL
neconomy with imperfect comeptition markets is not able to reach the maximal level of total utility
System failure

Consequence of imperfect competition
Y
PPF
x*
y*
E'
X
E
PX/PY=MCX/MCY
PX>MCX /PY=MCY
UA+UB
U'A+U'B
y*'
x*'
Good Y is sold on the perfect competition market, good X on the imperfect competition market – the
economy´s total utility is lower than upon the perfect competition markets of both goods

The failure of system elements



Externalities
nEXTERNALITY = negative or positive effect resulting from the action of the specific subject to the
other subject
nnegative externality – the originator causes negative effects (costs) to someone else
npositive externality – the originator causes positive effects (utilities) to someone else – the
originator does not get paid for the utilities
n (!!!) – the existence of externalities itself is not the economical problem – the problem is the
result of the externalities existence

Negative externality
nthere is produced over-optimal volume of goods with negative externality – costs on the
externality elimination are not calculated within the price of goods
nhow to include these costs?
npossible solution: tax on consumption of goods with negative externality

nthere is a sub-optimal production of goods with positive externality – the external utilities are
not included in the demand for such a good
npossible solution: subsidies to the producers of goods with positive externalities
Positive externality

The existence of public goods
nPUBLIC GOOD must fulfill following conditions:
nits consumption is non-rivalrous – if one consumer consumes the good, the volume of the good would
not decrease (i.e. the use of roads)
nits consumption is non-excludable – there is no effective way to exclude non-paying consumers out
of consumption (i.e. the use of mass transport)
n(!!!) publice good ≠ publicly provided good

n firms would not be generally interested in production of public goods, because:
nconsumers would like to consume the goods, but not all would like to pay for them (stow-away
problem)
npossible solution: providing of public goods by the public sector – public sector disposes
relatively effective instruments
Public good and inefficiency

Asymteric information
1.Principal-agent relationship
2.Adverse selection

Principal – agent
nprincipal delegates competences on the agent (deputy)
nagent has generally better info, so:
nagent may increase his/her utility of the principal´s accord
ni.e.: stockholders (principals) delegate their competences on the management (agents) to manage
the corporation
nmanagement – better info = possibility to increase its utility of the stockholders accord
nis there any loss of the utility? or is there only a utility redistribution?

Adverse selection
nexistence of imperfect info may lead to the low quality good markets
nexample: market of used cars...
n... if everyone expects low quality cars, subject which would offer a high quality car does not
get an adequate price (consumers expect low quality cars – low price)... the result is:
nnoone would like to offer a high quality car – all used cars on the market have the low quality

Solution of market failures
nthe matter of attitude
nsome economists (and politicians) would prefer the state interventions, but...
nsome economists (and politicians) would prefer the free market – main argument:
nstate interventions would not increase the total utility, but only redistribute it (see Rothbard)

Coase theorem
naccent on the enforcement of owner´s rights
nCoase says: upon zero transaction costs the most efficient solution of externalities is the
enforcement of owner´s rights...
n... in other words – enforcement of owner´s rights is efficient up to the level of transaction
costs
n... if transaction costs on owner´s rights > the costs resulting from the negative externality (or
sacrificed utility from the positive externality), it is more efficient to solve the externalities
via the state