Market Failure.pptx

1. Market Failures and Collective Action

2. Market Equilibrium • Equilibrium in the market results in maximum benefits, and therefore maximum total welfare for both the consumers and the producers of the product.

3. Welfare of Consumer and Producer • Consumer surplus measures economic welfare from the buyer’s side. • Producer surplus measures economic welfare from the seller’s side.

4. • Consumer Surplus – Willingness to pay is the maximum amount that a buyer will pay for a good. – It measures how much the buyer values the good or service – Consumer surplus is the buyer’s willingness to pay for a good minus the amount the buyer actually pays for it.

6. • Producer Surplus – Producer surplus is the amount a seller is paid for a good minus the seller’s cost. – It measures the benefit to sellers participating in a market.

8. MARKET EFFICIENCY • Efficiency is the property of a resource allocation of maximizing the total surplus received by all members of society.

9. MARKET EFFICIENCY Consumer Surplus = Value to buyers – Amount paid by buyers and Producer Surplus = Amount received by sellers – Cost to sellers

10. MARKET EFFICIENCY Total surplus = Consumer surplus + Producer surplus or Total surplus = Value to buyers – Cost to sellers

11. MARKET EFFICIENCY • In addition to market efficiency, a social planner might also care about equity – the fairness of the distribution of well-being among the various buyers and sellers.

12. Consumer and Producer Surplus in the Market Equilibrium Copyright©2003 Southwestern/Thomson Learning Producer surplus Consumer surplus Price 0 Quantity Equilibrium price Equilibrium quantity Supply Demand A C B D E

13. MARKET EFFICIENCY • Three Insights Concerning Market Outcomes – Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay. – Free markets allocate the demand for goods to the sellers who can produce them at least cost. – Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus.

14. The Efficiency of the Equilibrium Quantity Copyright©2003 Southwestern/Thomson Learning Quantity Price 0 Supply Demand Cost to sellers Cost to sellers Value to buyers Value to buyers Value to buyers is greater than cost to sellers. Value to buyers is less than cost to sellers. Equilibrium quantity

15. quantity price Exploitative price offered by private trader Domestic supply curve Total Supply curve (Domestic s + Foreign) Domestic Supply curve after cooperative A B C Fall in cost of production due to cooperative P1 Q1 D1 Grains from Cooperative P1, Q1 is initial equilibrium price and quantity D1 is initial amount of milk purchased from domestic producers Producer Surplus (PS) lost due to exploitative pricing of domestic milk PS obtained by domestic milk producers when price is exploitative ABC is the Total Surplus (TS) after cooperative is formed TS increased after cooperative Both consumer surplus and PS increase after cooperative

16. Evaluating the Market Equilibrium • Collective Action increases Economic Efficiency • Free market alone is less efficient

17. Evaluating the Market Equilibrium • Market Power – If a market system is not perfectly competitive, market power may result. • Market power is the ability to influence prices. • Market power can cause markets to be inefficient because it keeps price and quantity from the equilibrium of supply and demand.

18. Externalities • Externalities – created when a market outcome affects individuals other than buyers and sellers in that market. – Welfare more than just the value to the buyers and cost to the sellers. • When buyers and sellers do not take externalities into account when deciding how much to consume and produce, the equilibrium in the market can be inefficient.

19. Market Failures • Market fails to produce the right amount of the product • Resources may be • Over-allocated • Under-allocated LO1 5-19

20. • Recall: Adam Smith’s “invisible hand” of the marketplace leads self-interested buyers and sellers in a market to maximize the total benefit that society can derive from a market. But market failures can still happen.

21. EXTERNALITIES AND MARKET INEFFICIENCY • An externality refers to the uncompensated impact of one person’s actions on the well- being of a bystander. • Externalities cause markets to be inefficient, and thus fail to maximize total surplus.

22. EXTERNALITIES AND MARKET INEFFICIENCY • An externality arises... . . . when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect.

23. EXTERNALITIES AND MARKET INEFFICIENCY • When the impact on the bystander is adverse, the externality is called a negative externality. • When the impact on the bystander is beneficial, the externality is called a positive externality.

24. EXTERNALITIES AND MARKET INEFFICIENCY • Negative Externalities – Automobile exhaust – Cigarette smoking – Barking dogs (loud pets) – Loud stereos in an apartment building

25. EXTERNALITIES AND MARKET INEFFICIENCY • Positive Externalities – Immunizations – Restored historic buildings – Research into new technologies

26. EXTERNALITIES AND MARKET INEFFICIENCY • Negative externalities lead markets to produce a larger quantity than is socially desirable. • Positive externalities lead markets to produce a smaller quantity than is socially desirable.

27. Pollution and the Social Optimum Equilibrium Quantity of Aluminum 0 Price of Aluminum Demand (private value) Supply (private cost) Social cost QOPTIMUM Optimum Cost of pollution QMARKET

29. Other Reasons of Market Failure • Incomplete Information – Consumers do not have accurate information about market prices or product quality – Lack of information may give producers an incentive to supply too much or too little – Consumers may not buy product even though it is beneficial to buy – Lack of information may prevent some markets to develop

30. Government Intervention • Tax – Negative externality • Subsidy – Positive externality

31. PRIVATE SOLUTIONS TO EXTERNALITIES • Moral codes and social sanctions • Charitable organizations • Integrating different types of businesses • Contracting between parties

32. Private Solutions: Coase Theorem • The Coase Theorem is a proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own. • Whatever the initial distribution of rights, the interested parties can reach a bargain in which everyone is better off and the outcome is efficient – distribution of property rights have implications • Transactions Costs – Transaction costs are the costs that parties incur in the process of agreeing to and following through on a bargain.

33. Why Private Solutions Do Not Always Work • Sometimes the private solution approach fails because transaction costs can be so high that private agreement is not possible. • Number of individuals involved on both sides high • Need to resolve Collective Action Problem

34. PUBLIC POLICY TOWARD EXTERNALITIES • When externalities are significant and private solutions are not found, government may attempt to solve the problem through . . . – command-and-control policies. – market-based policies.

35. PUBLIC POLICY TOWARD EXTERNALITIES • Command-and-Control Policies – Usually take the form of regulations: • Forbid certain behaviors. • Require certain behaviors. – Examples: • Requirements that all students be immunized. • Stipulations on pollution emission levels set by the Environmental Protection Agency (EPA).

36. PUBLIC POLICY TOWARD EXTERNALITIES • Market-Based Policies – Government uses taxes and subsidies to align private incentives with social efficiency. – Pigovian taxes are taxes enacted to correct the effects of a negative externality.

37. PUBLIC POLICY TOWARD EXTERNALITIES • Examples of Regulation versus Pigovian Tax – If the EPA decides it wants to reduce the amount of pollution coming from a specific plant. The EPA could… – tell the firm to reduce its pollution by a specific amount (i.e. regulation). – levy a tax of a given amount for each unit of pollution the firm emits (i.e. Pigovian tax).

38. PUBLIC POLICY TOWARD EXTERNALITIES • Market-Based Policies • Tradable pollution permits allow the voluntary transfer of the right to pollute from one firm to another. – A market for these permits will eventually develop. – A firm that can reduce pollution at a low cost may prefer to sell its permit to a firm that can reduce pollution only at a high cost.

39. Climate change – the biggest market failure the world has ever seen?

40. The equivalence of corrective taxes & pollution permits Price of pollution In panel (a), the EPA sets a price on pollution by levying a corrective tax, and the demand curve determines the quantity of pollution. In panel (b), the EPA limits the quantity of pollution by limiting the number of pollution permits, and the demand curve determines the price of pollution. The price and quantity of pollution are the same in the two cases. 0 Quantity of pollution (a) Corrective tax (b) Pollution permits Demand for pollution rights Q P Corrective tax 1. A corrective tax sets the price of pollution . . . 2. . . . which, together with the demand curve, determines the quantity of pollution. Price of pollution 0 Quantity of pollution Demand for pollution rights P Q Supply of pollution permits 1. Pollution permits set the quantity of pollution . . . 2. . . . which, together with the demand curve, determines the price of pollution.

41. Carbon Trading • Carbon Trading is market-based mechanism to incentivise reduction of greenhouse gas emissions in a cost-effective and economically- efficient manner • Under Carbon trading, a country having more emissions of carbon is able to purchase the right to emit more and the country having less emission trades the right to emit carbon to other countries. More carbon emitting countries, by this way try to keep the limit of carbon emission specified to them

42. Carbon Markets • EU Emissions Trading System (EU-ETS) – Operates in the 28 EU countries and the three EEA- EFTA states (Iceland, Liechtenstein and Norway) – covers more than 11,000 power stations and industrial plants • Clean Development Mechanism (CDM) – emission-reduction projects in developing countries can earn certified emission reduction credits. – These saleable credits can be used by industrialized countries to meet a part of their emission reduction targets under the Kyoto Protocol

43. Carbon Credits • A carbon credit is a generic term for any tradable certificate or permit representing the right to emit one tonne of carbon dioxide or the mass of another greenhouse gas with a carbon dioxide equivalent • Carbon Credits are the production cost, for which, ultimately the consumer pay • Cap and trade (or emission trading) – compliance market – a limit (or "cap") on certain types of emissions or pollutions is set, and companies are permitted to sell (or "trade") the unused portion of their limits to other companies that are struggling to comply. • Offset trading (trading in project based carbon credit) – voluntary market – restore forests, update power plants and factories or increase the energy efficiency of buildings and transportation – UN's Clean Development Mechanism (CDM) is the largest offsetting scheme with almost 3,000 registered projects in the global South as of April 2011 – Offsetting does not reduce emissions, but allows companies and governments in the North that have the historical responsibility to clean up the atmosphere to buy credits from projects in the South.

44. CDM in India • ONGC has 6 CDM projects registered with UNFCCC (United Nations Framework Convention on Climate Change) and is the only PSU to achieve this feat. • Carbon Trading in Ankleshwar – A sulphuric acid treatment plant, using technology imported from Canada, and a pharmaceutical company wanting new technology to help cut nitrogen dioxide emissions are among those seeking revenue from carbon credits • NGOs and MFIs – SEWA and Grameen Shakti for solar lighting – CTRAN, A BASIX group company for solar water heaters

45. Carbon Market Failures • No legally binding agreement to reduce emission • More credits allocated than needed – Low price of carbon – No incentive for carbon saving • "total lack of environmental integrity“ of CDM • High transaction cost on the process for applying for mitigation and adapting financing • Need International Collective action – Provision of global public good – The transparency and comparability of national action across a range of dimensions of effort are key to mutual understanding and recognition of what others are doing, as well as ensuring public accountability

46. Efforts • Kyoto Protocol – 1997 – Binding international action and agreed specific commitments from 2008 to 2012 – Entered into force 2005 and ratified by 162 countries – "common but differentiated responsibilities.“ – Market based mechanisms (Carbon market) – US and Australia declined to join the Protocol • Post-Koyoto: China, India, and the United States have all signaled that they will not ratify any treaty that will commit them legally to reduce CO2 emissions

47. United Nations Framework Convention on Climate Change • UNFCCC is an international environmental treaty negotiated at the Earth Summit in Rio de Janeiro in 1992 • Outlines how specific international treaties (called "protocols" or "Agreements") may be negotiated to set binding limits on greenhouse gases.

48. • Conference of Parties – The COP is the supreme decision-making body of the Convention (UNFCCC ) – COP is to review the national communications and emission inventories submitted by Parties. Based on this information, the COP assesses the effects of the measures taken by Parties and the progress made in achieving the ultimate objective of the Convention. – COP serve as the meeting of the Parties to the Kyoto Protocol (CMP) • Collection Action

49. COP 21 or CMP 11 - 2015 Paris Agreement • Holding the increase in the global average temperature to well below 2°C above pre- industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre- industrial levels • Making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development • reflect equity and the principle of common but differentiated responsibilities and respective capabilities, in the light of different national circumstances.

50. Ratification • reflect equity and the principle of common but differentiated responsibilities and respective capabilities, in the light of different national circumstances. – USA ??? China ???? • Each country that ratifies the agreement will be required to set a target for emission reduction or limitation, called a "nationally determined contribution," or "NDC," but the amount will be voluntary • Name and shame • No binding constraint • 2017 USA withdrew from Paris Agreement (four-year exit process)

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