<2.10 MARKET FAILURE>

--DEFINITION--

--WHAT WE KNOW SO FAR--

So far we have seen how CONSUMERS and PRODUCERS interact through DEMAND and SUPPLY to determine the EQUILIBRIUM PRICE and QUANTITY. But why is this outcome deemed to be the MOST EFFICIENT OUTCOME?
Not sure, then think about this...

"Would it be efficient if the quantity produced of any good was offered to those consumers that didn't really value the good whilst the producers of the goods were those that wasted the most time and resources making it?"

Of course not! As such the 'INVISIBLE HAND' of the free market in which every consumer wants to maximise satisfaction and every producer wants to maximise profits should assure (in theory) the following...

"...in the free market system the equilibrium quantity of goods produced (Qe) is bought by those consumers who gain the most BENEFIT from consuming it, whilst the lowest COST, least wasteful (most efficient) producers are the only ones that make it."

Sounds perfect right? We satisfy the most wants using the least amount of our limited resources. We love the market system Whoop! Whoop!

--WHAT IS MARKET FAILURE?😭--

Not so fast as sadly the market equilibrium isn't always the best outcome and the MARKET system actually FAILS😭.
"Whenever the EQUILIBRIUM QUANTITY determined through free market forces (Qfm), DOES NOT EQUAL the SOCIALLY OPTIMAL AMOUNT (Qso). Market Failure exists."
In other words sometimes in the free market the quantity of certain goods and services IS NOT THE SOCIALLY OPTIMAL AMOUNT (Qfm ≠ Qso) meaning that some GOODS + SERVICES are OVERPRODUCED + CONSUMED, while some GOODS + SERVICE are UNDERPRODUCED + CONSUMED and some are NOT EVEN PRODUCED AT ALL.
Below we can see that QSo is the efficient quantity yet the free market quantity can be to the right or left of this amount. Of course when Qso = Qfm, there is NO MARKET FAILURE.

--TASK--

Complete each of these sentences with a list of three goods/services:
- - - - "In Taiwan there are too many..."
      - "In Taiwan there aren't enough..."
      - "In Taiwan the government is the only one that produces..."
Explain your choices! What do they have in common?

--CAUSES/CONSEQUENCES--

--EXTERNALITIES--

...THE PRODUCER'S COSTS/BENEFITS ARE NOT FULLY INCLUDED:

...THE CONSUMER'S COSTS/BENEFITS ARE NOT FULLY INCLUDED:

--IMPORTANT TERMS--

PRIVATE COSTS = the costs an economic agent incurs from producing or consuming a good. For a producer this impacts their willingness to supply and for a consumer it impacts their willingness to demand.
PRIVATE BENEFIT = the benefits an economic agent enjoys from the production or consumption of a good. For a producer this impacts their willingness to supply and for a consumer it impacts their willingness to demand.
EXTERNAL COSTS = costs incurred by to 3rd parties who are not involved in the production or consumption of the good, and who receive no compensation from the producer/consumer. These external costs are called 'NEGATIVE EXTERNALITIES' and the goods that produce them are called 'DEMERIT GOODS'.
EXTERNAL BENEFITS = benefits enjoyed by 3rd parties what are not involved in the direct production/consumption of the good by the producer/consumer who does not compensate the consumer. Goods that create 'EXTERNAL BENEFITS' are called 'MERIT GOODS'.
SOCIAL COSTS = PRIVATE COSTS + EXTERNAL COSTS
SOCIAL BENEFITS = PRIVATE BENEFITS + EXTERNAL BENEFITS

--TASK--

TASK: Imagine TES wishes to open a NEW CAMPUS near Taipei 101. Do a cost : benefit analysis. Do you think the benefits outweigh the costs?

--INTRODUCTION--

After completing the previous task, you should now realise that when an economic activity takes place it creates EXTERNAL COSTS and EXTERNAL BENEFITS (Also known as 'EXTERNALITIES') to 3rd parties who receive or pay no compensation, but the problem with the price mechanism is that it only takes into account the PRIVATE COSTS and BENEFITS of consumers and producers.
Therefore 'SOCIETY'S FULL COSTS (PRIVATE COSTS + EXTERNAL COSTS)' and 'SOCIETY'S FULL BENEFITS' (PRIVATE BENEFIT + EXTERNAL BENEFIT) are not incorporated into the system* and so the free market equilibrium (Qfm) will DEVIATE from the efficient level (Qso) meaning the market has 'FAILED'.
*Note: If there are NO EXTERNALITIES then then Qfm = Qso

--WHEN EXTERNAL COSTS EXIST--

Let's use the PRODUCTION OF BEEF as our example. Like any producer the SUPPLY OF BEEF is based on the PRIVATE COSTS that farmers incur, such as animal feed, water etc..., however as we know cows produce methane which contributes to CLIMATE CHANGE which creates many costs for THIRD PARTIES which the farmer DOES NOT COMPENSATE THEM FOR.
So if this EXTERNAL COST was added to the farmer's private costs, then their cost of production would rise and their SUPPLY CURVE WOULD SHIFT LEFTWARDS, which would mean a lower equilibrium quantity. To sum up, we can say that the farmers supply curve does not represent the SOCIAL COSTS of their economic activity, meaning their supply curve is INEFFICIENT, and hence the free market has OVERPRODUCED beef.

--TASK--

Rewrite the Beef example using one of the external costs you listed in the task above regarding the expansion of TES to a new campus.

--WHEN EXTERNAL BENEFITS EXIST--

Let's use vaccinations as our example. Like any consumer the DEMAND FOR VACCINATIONS is based on their PRIVATE BENEFITS that the individual enjoys, however as we know when one more person gets vaccinated society benefits from having one less person to transmit disease, thus third parties benefit, who do NOT COMPENSATE the original buyer .
So if this EXTERNAL BENEFIT was added to the individual's benefit then their DEMAND CURVE WOULD SHIFT RIGHTWARDS, which would mean a higher equilibrium quantity. To sum up, we can say that the individuals demand curve does not represent the FULL SOCIAL BENEFITS of their economic activity, meaning their demand curve is INEFFICIENT, and hence the free market has UNDERPRODUCED vaccinations.

--TASK--

Rewrite the vaccination example using one of the external benefit you listed in the task above regarding the expansion of TES to a new campus.

--LACK OF PUBLIC GOODS--

...CUSTOMERS CAN'T BE CHARGED INDIVIDUALLY:

--DEFINITION--

PUBLIC GOODS are goods or services that have the following TWO CHARACTERISTICS:
- - - (i) NON-EXCLUDABLE
    - (ii) NON-RIVALROUS.

--WHY A MARKET FAILURE?--

Like any good, the production of public goods INVOLVES PRIVATE COSTS OF PRODUCTION, as such PRODUCERS WILL ONLY BE PREPARED TO SUPPLY THE GOOD IF THEY CAN CHARGE A PRICE FOR IT AND MAKE PROFITS.
HOWEVER the fact that the good is NON-EXCLUDABLE MEANS IT IS UNLIKELY THAT CONSUMERS WILL BUY THE PRODUCT, as they will be RELUCT TO PURCHASE A GOOD AT THEIR OWN EXPENSE, GIVEN THAT OTHERS WILL CONSUME IT WITHOUT PAYING (This is termed the 'FREE-RIDER PROBLEM').
This LACK OF MARKET DEMAND means that the good, regardless of how much people desire it and gain benefit from its consumption, WILL NOT BE PROVIDED BY THE FREE MARKET, hence it is a MARKET FAILURE.

--TASK--

SKETCH THE CHART BELOW, THEN PLACE THE FOLLOWING GOODS/SERVICES IN THE MOST APPROPRIATE PLACES GIVEN THEIR RELATIVE EXCLUDABILITY AND RIVALRY. EXPLAIN YOUR CHOICES
- - - NATIONAL DEFENSE
    - OFS
    - TOLL ROADS
    - IPHONE
    - PUBLIC TOILETS
    - LIBRARY
    - PUBLIC WIFI
    - LIGHTHOUSE
    - MOTORWAYS
    - FISH IN THE OPEN SEA

--MONOPOLY ABUSE--

...THERE IS NO COMPETITION IN THE MARKET:

--INTRODUCTION--

One of the main features of the market system and the supply and demand model is the existence of COMPETITION, when a producer is inefficient and can only produce goods at a high price, they are FORCED OUT of the market by lower cost, more-efficient competitors, these high cost firms then REALLOCATE their resources to more suitable uses, leaving the low cost, more specialised firms to produce at lower prices. B-U-T🫤what if THERE IS NO COMPETITION????

--MONOPOLY ABUSE--

AMAZON, MICROSOFT, GOOGLE etc... are just a few well known companies that are so large and powerful within their markets (They are often referred to as 'MONOPOLIES'), they can actually PREVENT COMPETITION ('Abuse their monopoly power') entering the market to challenge them on price, as such they may not be the lowest cost producers and they can FIX PRICES above the Pso and produce BELOW the Qso.

--ASYMMETRIC INFO--

...BUYERS/SELLERS LACK INFORMATION ABOUT TRUE VALUE/COST:

The assumption is that consumers have FULL INFORMATION about the benefits they will gain from consuming a good and use this to guide their willingness to pay. For example you have a good idea about the benefits of consuming a banana, and therefore can make an 'informed decision' about how much you are willing to pay, but what if you lack the knowledge or are persuaded by advertising and pay a price that isn't really informed, in this case your demand curve will not be optimal and the efficient level will not be achieved.
THINK ABOUT IT!: Do you think you are 100% sure about the benefit that owning a MacBook will give you? Do you think the seller of a second hand phone is telling you the entire truth? Do you think the insurance customer is revealing all their illnesses when they negotiate insurance? How has 'branding' impacted your decision?

--SCENARIO # 1--

Do you think you could sell your 99% brand new phone for around 90% of the price you paid only a week ago? Why not?, Would you pay almost full price for a second hand iPhone 16 pro? Would you accept 50% off the price you paid for your brand new iPhone? What can we conclude about the 'market for almost new phones'?

--SCENARIO # 2--

SCENARIO#1 If we imagine that their exists an optimal level of teaching effort/pace by the teacher that is based solely on the verbal feedback they receive from students. However, the students, when asked "Do you understand?" do not fully disclose their true understanding due to fear of being embarrassed and always answer "Yes", what do you think will happen to the effort and pace of the teacher/class?

--SCENARIO # 3--

SCENARIO #3: Similarly, if we imagine that their exists an optimal level of teaching effort by the teacher that is based solely on the feedback they receive from examinations. However, the students do not fully disclose their revision effort level or indeed any issues in their homelife, the teacher will naturally label some strong students 'Weak', which will impact the pace and efforts of the teacher going forward. What do you think will happen?

--INTRODUCTION--

After discussing the above scenarios you should realise that efficiency depends on both parties having PEFECT INFORMATION ('SYMMETRICAL INFORMATION') regarding the true value of the costs and benefits of any economic activity, yet this rarely exists in the real world.
In other words, for the market to be efficient WE HAVE TO ASSUME THAT THE BUYER WILLINGNESS TO PAY IS FULLY REFLECTIVE OF THE BENEFIT THEY EXPECT TO RECEIVE FROM CONSUMPTION, and THAT THE SELLER'S WILLINGNESS TO ACCEPT IS FULLY REFLECTIVE OF THE BENEFIT THEY EXPECT TO RECEIVE FROM PRODUCTION,
but what if you can't accurately judge the benefit you receive, what if they end up paying higher prices for low quality goods?
For example, you are probably able to accurately judge the satisfaction you get from consuming an APPLE as you have PERFECT INFORMATION, and therefore can make a good judgement on the price you are willing to pay, which in turn impacts the allocation of apples,...
...however what about an APPLE MACBOOK? do you really have all the information to judge its value? are you being misinformed through advertising and branding? In other words you have IMPERFECT INFORMATION ('ASYMMETRICAL INFORMATION') about the satisfaction you will receive form consuming it, wouldn't this mean your demand curve is wrong? Your willingness to pay is inaccurate which will impact the allocation of resources.
Ask yourself: Do you know the satisfaction that you will get from studying IGCSE and IBDP in your future life? Is it worth it? Do you even need this to do the job you will eventually get?, Do you think having IB is worth more than A-Levels hen applying to university? Do you think Starbucks coffee is superior to Mc Cafe? Do you think the demand for Gucci handbags is rationale?

--DEFINITION--

ASYMMETRIC INFORMATION refers to SITUATIONS WHERE BUYERS AND SELLERS DO NOT HAVE EQUAL ACCESS TO INFORMATION and this usually results in either an UNDERALLOCATION of the good or for the market to NOT EXIST at all.

--BUYER KNOWS MORE--

--SELLER KNOWS MORE--

--TASK--

After watching the video above explain the following:
"Why is health insurance for healthy people underprovided?"

--TASK--

After watching the video above explain the following:
"Why are good-quality used cars underprovided?"

--FACTOR IMMOBILITY--

RESOURCES ARE IMMOBILE AND CAN'T EASILY BE REALLOCATED:

Factor immobility is considered a market failure because it prevents factors of production (like labor and capital) from moving freely to where they are most needed, leading to inefficient allocation of resources and a suboptimal economic outcome, where production could be higher if factors were more mobile across sectors and regions; essentially, the market is unable to reach its full potential due to these limitations.

--MCQ--

--PAPER 2--

2-MARKER

4-MARKER

6-MARKER

8-MARKER

In both cases the optimal teaching effort and pace will not be achieved as we will likely slow the pace of the class based on IMPERFECT INFORMATION about the student's abilities. Strong students will basically not have a class optimised for them. In other words due to asymmetric information their doesn't exist a class optimsed for stronger students.