2. MARKET FAILURES IN FOCUS
MARKET FAILURE & INTERVENTION
Labour market Financial
Markets
Environmental
Market Failure
Product
Markets
Housing
Market
Commodities
Markets

3. KEY MARKET FAILURE CONCEPTS TO REVISE
MARKET FAILURE & INTERVENTION
• Economic welfare outcomes
• Self-interested behaviour
• Rational behaviour
• Consumer and producer surplus
• Private benefit and private cost
• Social welfare outcomes
• Social benefit and social cost
• Economic efficiency
• Allocative
• Productive (including economies of scale)
• Dynamic

4. COMPLETE AND PARTIAL MARKET FAILURE
Complete Failure:
Pure Public Goods
Partial Failure:
Negative externalities from
production
MARKET FAILURE & INTERVENTION

5. PUBLIC GOODS
Sanitation
infrastructure
Flood defence
projects
Crime control for a
community
Reduced risk of
disease from
vaccinations
Freely available
knowledge e.g.
online learning
Public service
broadcasting
MARKET FAILURE & INTERVENTION

6. NEGATIVE EXTERNALITIES FROM PRODUCTION
Air pollution from factories Pollution from fertilizers Industrial waste
Noise pollution Collapsing fish stocks Methane emissions
MARKET FAILURE & INTERVENTION

7. NEGATIVE EXTERNALITIES FROM PRODUCTION
Marginal
Private Cost
(MPC)P1
Q1
Marginal
Private Benefit
(MPB)
Costs,
Benefits
£s
Marginal
Social Cost
(MSC)
Q2
P2
The equilibrium
output delivered
by a free market is
at Q1 where MPB =
MPC and it is
allocatively
inefficient.
We assume here
that there are no
externalities from
consumption,
therefore
MSB=MPB
Note
If MSC pivots
away from
MPC then the
marginal
external cost
of extra
output is
increasing Output/Quantity
MARKET FAILURE & INTERVENTION
Diagrams should
be ACE! That
means remember
to label the Axes,
Curves and all
Equilibrium points

8. NEGATIVE EXTERNALITIES FROM CONSUMPTION
Particulates from
vehicle pollution
Household
waste
Noise pollution
from neighbours
Air pollution
from smokers
Traffic
congestion
Impact of
addiction on
families
Litter from
tourists
Spillover costs
from rising levels
of obesity
MARKET FAILURE & INTERVENTION

9. NEGATIVE EXTERNALITIES FROM CONSUMPTION (AQA)
MARKET FAILURE & INTERVENTION
MSB
MPB
MPC = MSC
Benefit,
Cost
Quantity consumedQ1 Q2
Deadweight loss of social
welfare = ABC
A
C
B
Social optimum is where MSB
= MSC
With negative consumption
externalities, if consumption
of a product reduces benefits
enjoyed by third parties, the
benefits to society are less
than benefits obtained by
individuals consuming the
product. Negative
externalities lead to
overconsumption and hence
overproduction
Remember your
ABC’s with
diagrams –
Accurate, Big and
Clear

10. POSITIVE EXTERNALITIES FROM CONSUMPTION
Health programmes
e.g. HNS services
Early years
education e.g.
nursery provision
Subsidised Bike
Schemes in urban
areas
Public libraries /
community spaces
Museums and
Galleries
Free school meals /
nutritional advice
MARKET FAILURE & INTERVENTION

11. POSITIVE EXTERNALITIES FROM CONSUMPTION
Costs, Benefits
£s
Output/Quantity
Marginal
Private Cost
P1
Q1
Marginal Private
Benefit
Marginal Social
Benefit
P2
Q2
If the market
price ignores
positive
externalities,
then there will
be under-
consumption
Social optimum position
is output Q2 whereas the
market equilibrium is Q1
This is the area of social welfare loss
because the market output Q1 is lower
than the socially efficient level
MARKET FAILURE & INTERVENTION

12. POSITIVE EXTERNALITIES FROM PRODUCTION
MARKET FAILURE & INTERVENTION
Open Source Software
made freely available
to users
Positive spillover
effects from research
and development

13. POSITIVE EXTERNALITIES FROM PRODUCTION (AQA)
MARKET FAILURE & INTERVENTION
MPB
MPC
Benefit,
Cost
Quantity producedQ2 Q1
A
C
B
MSC
Deadweight loss
of social welfare
Social optimum is
where MSB = MSC
Because there are positive
externalities in
production, the marginal
social cost of production is
less than the marginal
private cost of production.
A good example arises
from universities making
their research available as
a public good.
Positive production
externalities shifts the
supply curve to the right.

14. MARKET FAILURE AND NET SOCIAL WELFARE LOSS
MPB
MSC
Benefit,
Cost
Q2 Q1
B
A
MPC
MSB
Social optimum is
where MSB = MSC
There are net social
costs in this market)
i.e. it is costing
society more to
produce these units
than society is
valuing these units.
As a result, the
social optimum
output is lower than
the free market
equilibrium output.
A: Where MPB=MPC
B: Where MSB = MSC Output/Quantity
MARKET FAILURE & INTERVENTION

15. MARKET FAILURE AND NET SOCIAL WELFARE BENEFITS
MPB
MSC
Benefit,
Cost
Q1 Q2
B
A
MPC
MSB
Social optimum is
where MSB = MSC
In this example, there
are net social benefits
from producing and
consuming the
product. This is
because there are
substantial external
benefits from
consumption.
The free market
mechanism might
under-provide this
product again leading
to market failure.A: Where MPB=MPC
B: Where MSB = MSC Output/Quantity
MARKET FAILURE & INTERVENTION

16. MERIT GOODS
MARKET FAILURE & INTERVENTION
Costs,
Benefits
£s
Output / quantity
MPC
P1
Q1
MPB
MSB
P2
Q2
One cause of under-
consumption and therefore
market failure is that people
will only consider their own
private costs and benefits –
leading to a private optimum
output of Q1.
If the consumption of merit
goods leads to external
benefits, the optimum output
from society’s point of view is
higher at Q2. The under-
consumption of a merit good
is a cause of market failure.
P3
Welfare loss arising from
under-consumption
Merit goods give
rise to external
benefits

17. DE-MERIT GOODS
MARKET FAILURE & INTERVENTION
High Caffeine
Energy Drinks
High-fat, high-
sugar & high-salt
foods
Violent films and
games
Hands-free mobile
phones in vehicles
Alcohol fraud and
binge drinking
Tobacco products

18. INFORMATION GAPS – OVER-ESTIMATING BENEFITS
Costs,
Benefits
£s
MPC
P1
Q1
MPB (fuller
information)
P2
Q2
Individuals may have
imperfect information
about their own
private benefits. If
they had better/fuller
information on the
benefits to
themselves of
consuming a good or
service, the marginal
private benefit curve
would shift lower
leading to a smaller
equilibrium quantity
MPB (limited
information)
Market demand would
be lower if consumers
had fuller information
Output/Quantity
INDIVIDUAL DECISION MAKING
Simply drawing a
diagram from
memory will likely
only allow you to
gain AO1 marks. To
be able to access
higher-skill marks,
you will need to
make a change or
adapt your diagram
– perhaps shift a
curve, indicate a
particular important
area and so on.

19. INFORMATION GAPS
Risks from using
tanning salons
Addiction to
painkillers & other
drugs
How to gain entry
to elite university
courses
Complexity of
personal pension
schemes
Uncertain quality
in buying second
hand products
Knowledge of the
nutritional content
of foods
Cowboy builders
or other “rip-off
merchants”
Tourist bazaars or
buying and selling
antiques
INDIVIDUAL DECISION MAKING

20. PURPOSE OF GOVERNMENT INTERVENTION
Taxes & Subsidies
Maximum &
Minimum Prices
Regulating the Market
State Ownership /
State Funding &
Provision
Government
intervention
MARKET FAILURE & INTERVENTION

21. TOPICAL EXAMPLES OF GOVERNMENT INTERVENTION
MARKET FAILURE & INTERVENTION
Minimum alcohol
pricing
Capping pay day
loan interest rates
2018 UK Sugar Levy Maximum single
bets on FOBTs
Minimum price for
carbon emissions
Strict C02 emissions
limits for vehicles
Proposed plastic
straw, stirrer bans
Apprenticeship
Levy for firms

22. REGULATIONS TO CORRECT FOR EXTERNALITIES
Smoking bans Minimum age laws
Maximum C02
emissions for vehicles
Recycling directives
Ban on diesel cars in
the UK (2040)
Fishing quotas
MARKET FAILURE & INTERVENTION
Regulation is a non-market based approach to addressing market failures

23. REGULATIONS TO CORRECT FOR EXTERNALITIES
Case for regulating activities
causing negative externalities
Costs / disadvantages of adding
extra regulation of industries
• Regulation acts as a spur for
business innovation e.g. to cut
the level of carbon emissions
• High cost of enforcement and
weak penalties might make
regulations ineffective
• Regulation may be more
effective if demand is
unresponsive to price changes
• Regulations can lead to
unintended consequences a
cause of government failure
• Regulations can be gradually
toughened each year – this will
stimulate capital investment e.g.
C02 emissions from vehicles
• The cost of regulations can
discourage small businesses
and therefore lead to less
competition in markets
MARKET FAILURE & INTERVENTION

24. GOVERNMENT FAILURE
Political self interest /
influence of political
lobbying
Policy myopia – i.e. the
search for “quick fixes”
Regulatory capture –
regulators operating in
interests of producers
Information failures &
failure to rigorously
test a policy
Disincentive effects
affecting both
consumers and
producers
High Enforcement /
Compliance Costs of an
intervention
Conflicting Policy
Objectives e.g.
environment and
economic growth
Damaging effects of
regulatory “red tape”
on business
competitiveness
MARKET FAILURE & INTERVENTION

25. EVALUATING GOVERNMENT INTERVENTION IN MARKETS
MARKET FAILURE & INTERVENTION
• How significant is the market failure? (consequences)
• Can the market / price mechanism find some solutions?
• What are the likely consequences of not intervening?
• How effective is an intervention? (i.e. consider alternatives)
• Who are the winners / losers from an intervention?
• Consider potential for one or more government failures
• Which works best in the long run? – market-based or
regulatory (“command and control”) approaches?
• What impact might behavioural interventions have? (e.g.
nudges such as changing defaults, choice architecture)