Chapter 2.

10
Market failure
2022 Nov
IGCSE Economics Y9
Revision:

1. What is a market economic system?

2. What are the advantages of market economy?
3. What are the disadvantages of market economy?
 Do you remember what the
characteristics of market economy are?
The three key questions Planned economy Market economy
Who determines what is the government the consumers
produced ?
Resources are allocated by th the directives the price mechanism
e …?
Land and capital are owned…? the public sector the private sector
 Private and public sector: a few terms

Private sector Public sector state-owned enter

prises (SOEs) Privatisation
firms/business The part of the the sale of
organisations economy owned, organisations own public sector
which are owned managed and con ed by the govern assets to the
by shareholders trolled by the gov ment which sell pr private sector
or individuals ernment oducts
 What are the advantages of a market
economy?
For
consumers
choices
Price sig low prices
nals

For firms
As a community, those who
The advantages come from earn high profit have the inc
the competitive pressures.
Rewarded/puni entive to innovate and expa
ß the importance of compe shed nd and in turn benefit the na
tition and incentives tion.
by the market
 What are the disadvantages of a market economy?
• Consumer side
• Advertising distorts consumer choices

• Enterprise side
• Only little competition in practice (monopoly)
• Not be able to respond to consumer desires
• Advertising distorts consumer choices

• Society side
• Market failure (pollution, etc.)
• Free riders
• Unfair social outcomes
• Difference in income increase over time
PED/PES MCQ review

(see another PPT )

Today’s aim
Nov 10
Week 13

Rival goods & public goods

 The Advantages of market economy: efficiency

• (1) Allocative efficiency

• (2) Productive efficiency
• (3) Dynamic efficiency

is the efficiency when it produc

When resourc
occurring over es at the lowes es are allocate
time as a result t possible cost d to produce t
of investment a per unit. he right produ
nd innovation cts in the right
quantities.
• But, is it possible that sometimes
the market is not efficient?
• When the market fails to produce the products
that consumers demand

Not in the right

Not at the lowest Not efficient in
quantities
possible cost the long run

And how do we know

when there is market
failure? The indicators
can be…
The super fans of Market
from the class of Y9 Opt5

Planet M
Will they be produced in your planet (when left to market forces)?
The “no” products/services

What are the similarities

between them?
What are the similarities of the “no”
products/services?
Public
goods

Non-excludable Non-rival
non-excludable non-rival
It’s not easy to consumption of the
locate each non- product by one
paying consumer more person does
and exclude them not reduce someone
from the payers else’s ability to
consume it.
 Excludable/ rival Let’s practice
(remember we consider usual situations only)
Can you think of more goods or services that will not be
produced, if left to market forces?
The “no” products/services
 Public goods:
A product that is:

(1) Non-rival;
(2) Non-excludable;

(3) Needs to be financed by taxation;

(4) Non-rejectable;
(5) The cost of supplying to one more consumer is often zero.
(6) It usually has strong positive externality

Example:
National defense, flood defense
 So, on the contrary, private goods are…?
• A product that is: --- being rival and excludable
• Examples:

• Confusing examples:
•
Education
Medical service
Homework (estimated time: 30 minutes)

1. Read the textbook pp.102-104

2. Copy the definition of the following terms on your notebook: third
parties, social benefits, social costs, private benefits, private cost
s, external costs, external benefits, socially optimum output
3. MCQs on google document
Today’s aim
Nov 10
Week 13

1. Definition of market failure

2. Types of market failure
3. Demerit goods
3. A short term review
Market failure
A situation in which
the market does not
allocate resources
in the best possible
way.
 Definition of market failure

market

good at not good

at

efficiency equity

But, sometimes…
not always
…
Misallocation of
resources …
… …
Demerit goods
Merit goods
 The nature of market failure:
• failure to take into account all costs and benefits

Why do governments Why do governments

usually levy fines on usually subsidise
polluting firms? universities?
Examples of certain goods in a market failure:
Can you summarise their similarities? from economic
perspectives
 Demerit goods

(1) Consumers do not fully realise how harmful the goods are1
(2) Over-consumed if left to market forces
(3) The government intervenes

Examples: cigarette, alcoholic beverages, recreational drugs, ga

mbling, junk food, prostitution, surrogacy

1: (i.e. the true cost is larger than the perceived cost)

Can you summarise can up with more examples?
How can governments intervene to correct the market failure?
How can governments intervene to correct the market failure?

taxation
banning

Educational public
campaign interest ads
 Demerit goods
Merit goods

The rest will be left after the assessment

Short term revision:
About the assessment:
1. 15 MCQs and 3 structure questions
2. A total of 45 marks
3. Time duration: 60 minutes
4. Revision scope: 1.1~~2.10 (public goods, demerit goods)
Today’s aim
12-01
Week 17

1. Merit goods
2. Cost and benefits
3. Private cost / private benefit
4. Social cost/ social benefit
Revision:

1. The nature of market failure is…?

2. The types of market failure are…?
3. The definition of demerit goods?
So, on the contrary, Merit Goods must be…?
 Merit goods

(1) Consumers do not fully realise how beneficial the goods are
(2) Under-consumed (if left to market forces)
(3) Provided/subsidised/compelled by the government

Examples: ?
 Merit goods

(1) Consumers do not fully realise how beneficial the goods are
(2) Under-consumed (if left to market forces)
(3) Provided/subsidised/compelled by the government

Examples: health care, education, museums, art galleries

 The nature of market failure 2:

• failure to take into account all costs and benefits

• ---produce the products that consumers demand…
• ---in the right quantities
• ---at the lowest possible cost

A bit different as you might think!

The Costs and Benefits in common people’s eyes
The Costs and Benefits in common people’s eyes
the Costs and Benefits in economists’ eyes
the Costs and Benefits in economists’ eyes (2)
The case of
external cost

cost: ? cost: ?
The renovation firm The household
benefit: ? benefit: ?
The case of
external cost

cost: their service cost: the fee you pay

The renovation firm The household
benefit: their service fee benefit: a nicely renovated home
The case of
external cost

• The neighbour: But who pays for my loss?

Has the market settled this problem?

The third party
People who are not
involved in the
consumption and
production activiti
es of others but
are influenced
negatively or
positively.
Let’s have a look at the opposite case.
The case of
external
benefit

cost: ? cost: ?
The university: The student:
benefit: ? benefit: ?
 The case of
external
benefit

cost: the cost to provide service cost: my tuition fee

The university: The student:
benefit: students’ tuition fee benefit: the certificate to find a job
The case of
external
benefit
The case of
external
benefit

Has the market settled this problem?

Do students pay extra fees for those interesting
and beneficial activities?
The third party
People who are not
involved in the
consumption and
production activiti
es of others but
are influenced
negatively or
positively.

Has the market settled this problem?

 External benefits
External costs
Benefits enjoyed b
Costs imposed on
y those who are
those who are not
not involved in the
involved in the
consumption and
consumption and
production activities
production activities
of others directly /
of others directly/
enjoyed by third
imposed on third
parties..
parties.
 That means…
• When calculating the strengths of an economy, we need to consider from
the perspective of a whole country– to include both private and social
benefit/ cost.

benefit benefit cost cost

Market
failure
 We calculate them this way

Private
cost +
external
cost
Private
benefit + External
benefit

Social cost Social benefit

Let’s have a look at another case.

If you were the boss of

the railway companies,
what would you do to
make people less bored
while waiting?

https://www.alamy.com/stock-photo-paris-france-interior-people-waiting-insi
de-gare-dausterlitz-historic-28970836.html
sci-fi poetry humor classic prose thrillers
http://www.yeoner.com/p/50088.html
 5,000 volunteers in 2015

private costs external costs

private benefits external benefits

 Homework
1. Read through pp.95-100
2. Definition memorisation: information failure, merit goods, d
emerit goods
3. Mcq of market failure (2) https://forms.gle/4VErFBoXUCa8
agV58 (24 questions in all)
4. Reading and note-taking 15 Powerful Public Interest
Ads https://www.business2community.com/marketing/15-powerful-public-interest-ads-0572156
So, how can governments intervene？
How can governments intervene：
 How can governments intervene：

taxation
banning

Educational public
campaign interest ads
How can governments intervene (cont’d):
How will a subsidy/
Subsidies indirect tax diagram Regualtion
look like?

maximum maximum
Indirect taxes price price

to boost
competition
Competition Nationalisation/
prevent remove regulate
policy mergers barriers monopolies Privatisation

Environmental tradeable
permits Direct provision
policy
Subsidy

A payment by a govern Show a subsidy with

-ment to reduce produc a D-S diagram.
-tion costs to increase
output or to improve
quality and to reduce
prices for consumers
 Subsidy

A payment by a govern
-ment to reduce produc
-tion costs to increase
output or to improve
Market with a subsidy Market with a tax
quality and to reduce
prices for consumers

Always shift the

supply curve!
 Maximum price

A price that producers

cannot charge above
a price ceiling set by
the government

Although this is not in the syllabus, it

appeared in 2020 Specimen past
paper.
The under-consumption of merit go
od and how we should react to it
 4th type of Market failure
• Information failure:
• lack of information
• inaccurate information
• asymmetric information
Possible cases of information failure: Source: tutor2u.com
Do not worry if you feel confused..
 Private
2 pairs of concepts: Public
Goods

goods
Concepts Characteristic Characterist examples
s1 ics 2 demerit
Examples: merit good
Public good good
s
Private good other goods
s

Characteristics Characteris Characteristics Examples:

1 tics 2 3

Merit
goods

Demerit
goods
 Private
2 pairs of concepts: Public
Goods

goods
Concepts Characteristic Characterist examples
s1 ics 2 demerit
Flood control system; merit good
Public goods Non-excludabili Non-rivalry national defense, National defense; good
ty dams Public education;
Public health care. other goods
Private goods excludability rivalry Private medical care,
private education

Characteristics Characteristi Characteristics Private education;

1 cs 2 3 Private health care;
Professional training,
Merit Consumers do Under- Needs subsidy/ etc.
goods fully not realise consumed if support from
the benefit of it left to market government
Demerit Consumers do Over- Needs restriction
goods fully not realise consumed if l from government
the harm of it eft to market
 The 4rd kind of market failure: Abuse of monopoly power

Price fixing • Where there is a lack of competition, a firm may…

Monopoly: • ---keep its costs high, charge a high price, may
--when two or produce a poor quality product
---a single sell more firms agr
er (in the mark ee to sell a pr • So, the government needs to prevent the abuse by:
et) oduct at the s • ---(1) removing restrictions on the entry of the
ame price market
(when major firms col • ---(2) make price fixing illegal
lude)
• ---(3) stop some firms from merging
 The 5th kind of market failure: Immobility of resources

• If there is a lack of mobility of resource

• ---the most efficient allocation of resources may not be achieved

• So, the government needs to:

• ---(1) improve education
• ---(2) provide training
• ---(3) provide investment grants
• ---(4) make house buying easier
 The 6th kind of market failure: short-termism

• Private sector firms, keen to earn high profits in the short term
• ---may under-invest

• So, the government needs to:

• ---(1) stimulate private sector investment by cutting taxes
• ---(2) invest itself
Market failure
1. externality Failure to take into account of
all costs and benefit (externality)

2. Information failure

3. merit goods, demerit goods, public goods

4. abuse of monopoly power

5. immobility of resources

6. short-termism
 01-26 Homework (estimated time: 45 minutes)

1. Read through pp.90-102

2. Copy the definition of the following terms on your notebook:
public goods; private goods; monopoly, price fixing
3. MCQ on market failure (2) https://forms.gle/YyyThWLmXte
T69nTA (20 questions)
4. Fill in the blanks:
 Revision of
Chapters 13 & 14
 Revision of Chapter 13
• Define a market economic system
• (1)consumers decide what is produced (2)price mechanism (3) land and capital privately owned
• Explain the difference between private and public sectors
• private: business organisations are owned by shareholders or individuals
• public: the part of economy controlled by the government
• Discuss the advantages and disadvantages of the market economy
• advantages: (1) responsive to changes (2) resources change automatically (3) choice (4)high quality
• disadvantages (market failure) (1) external cost (2) little competition (3) free riders (4) unfair outcomes (5) diffe
rences in income will increase over time
• Recognise how efficiency can be assessed (3 categories)
• (1) allocative efficiency (2) productive efficiency (3) dynamic efficiency
• right product, right quantity at lowest cost per unit resources used efficiently over time
• Describe the role of market forces in different countries
 Revision of Chapter 14
• Define market failure
• social cost vs. private cost
• external costs vs. external benefits
• Why external costs may cause market failure?

• Merit goods vs. demerit goods

• Why merit goods and demerit goods may cause market failure?

• Public goods vs. private goods

• Why do public goods cause market failure?
• Why does monopoly power cause market failure?
• Why does factor immobility cause market failure?

• Monopoly
• Public goods:
• ---Non-excludability : flood defence system (no matter I pay for it or not…)
• ---Non-rivalry : a lit street, the music played in a café…
•
• Merit goods:
• (1) consumers do not fully appreciate their value
• (2) will be under-consumed if left to market forces
• (3) have positive externalities
 Private
2 pairs of concepts: Public
Goods

goods
Concepts Characteristic Characterist examples
s1 ics 2 demerit
Flood control system; merit good
Public goods Non-excludabili Non-rivalry national defense, National defense; good
ty dams Public education;
Public health care. other goods
Private goods excludability rivalry Private medical care,
private education

Characteristics Characteristi Characteristics Private education;

1 cs 2 3 Private health care;
Professional training,
Merit Consumers do Under- Needs subsidy/ etc.
goods fully not realise consumed if support from
the benefit of it left to market government
Demerit Consumers do Over- Needs restriction
goods fully not realise consumed if l from government
the harm of it eft to market
1.29 CNY holiday Homework1 (estimated time: 120 minute
s)

1. MCQ: 2009Nov Paper1: Complete 1-9, ignoring 4,5. Check

the answers for yourself (see MB-Files)
2. Essay question 2009Nov Paper2 Q1c Q1d: (Mark scheme
also uploaded on MB)
02-04 CNY holiday Homework2 (estimated time: 120 minut
es)

1. MCQ: 2010June V1 Paper1: Complete 1-8. Check the ans

wers for yourself (see MB-Files)
2. Essay question 2010June V2 Paper2 Q1abcd: (Mark sche
me also uploaded on MB)
2.11 CNY holiday Homework3 (estimated time: 120 minute
s)

1. MCQ: 2010Nov V1 Paper1: Complete 1-7. Check the answ

ers for yourself (see MB-Files)
2. Essay question 2010Nov V1 Paper2 Q2a Q2c: (Mark sche
me also uploaded on MB)