Methods to correct Market failure (unfinished)

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  • Methods to correct Market failure
    • Taxation
      • How does taxation reduce negative externalities?
        • taxation aims to reduce negative externalities by internalising the negative externality. This is done by making consumers pay the full price of their consumption.(the social cost)
          • it does this by effectively increasing the cost of production of good, shifting supply to the left.
            • this causes the price to rise and the quantity demanded and supplied to fall.
              • this should reduce consumption to the socially efficient level if the tax is the size of the external cost.
        • how does reducing negative externalities solve market failure?
          • Market failure is where the free market mechanism fails to achieve economic efficiency
            • negative externalities mean that the  social cost is higher than the private cost.
              • this means that there is over production and consumption because good is cheaper than should be.
                • therefore resources are not being allocated efficiently and the free market mechanism has failed to achieve economic efficiency.
                  • if consumers are made to pay true cost of actions, consumption should fall to socially efficient level correct market failure.
      • comment points
        • Taxation provides incentive to reduce externalities further to reduce cost of production unlike regulation.
        • effectiveness depends on size of tax, whether is size of external cost/
          • also depends on the elasticity of demand
            • if inelastic, quantity demanded and therefore consumption wont change.
          • it is very hard to measure size of external cost, and therefore to set right size of tax
    • Regulation
      • How does regulation reduce negative externalities?
        • Regulation is used to override the workings of the free market mechanism
          • Market failure where the free market mechanism fails to achieve economic efficiency.
          • puts a cap on the quantity produced and therefore consumed.
            • this obviously reduces negative externalities as consumption can be set at the socially efficient level
              • regulation can be in many forms but this is most common to reduce negative externalities
      • comment points
        • Regulation provides no incentive for negative externalities to be reduced below cap.
        • regulation can be used to set optimal level of consumption.
          • Hard to determine where to cap and what the socially efficient consumption is.
            • if is very bad de merit good or lots of negative externality it may be better to ban altogether
      • Regulation can set standards  that should achieve what they see as an optimum scale of activity or use.
        • Setting standards requires accurate information. this is not always possible.
    • Tradable Permits
      • tradable  permits are a market based means of correcting market failure
        • They allow the owner the right to emit a specific level of pollution.
          • The total number of permits is strictly controlled as a means of limiting the overall level of pollution to what is seen as acceptable
            • The market aspect of these permits is that  they can be bought and sold at a price agreed between buyer and seller.
              • The incentive is for permit holders to achieve a lower level of pollution; any unused or partly used permits can be transferred  for a price to other firms having problems reaching the approves standard
                • This should correct market failure by setting the optimum level of pollution, reducing negative externalities and making polluters pay for their pollution.
        • In some respects Tradable permits therefore combine benefits of market solution with those of regulation.
          • If firms dont have enough permits to cover their pollution, they will be prosecuted.
          • This should correct market failure by setting the optimum level of pollution, reducing negative externalities and making polluters pay for their pollution.
      • Comment Points
        • It is costly and difficult to calculate and distribute perm its to polluters
        • costly to police and enforce
        • still difficult to decide what overall level of pollution is acceptable
    • Subsidy
      • a subsidy is a payment usually made by government to producers to encourage the production and consumption of a merit good or good that produces positive externalities.
        • A subsidy effectively reduces the cost of production in order to provide a higher level of production or consumption than would exist if it was left to the free market.
          • A subsidy effectively reduces the cost of production which shifts the supply curve right, causing the equilibrium price to fall and equilibrium quantity to rise.
            • A subsidy works very much like opposite to tax.
            • Subsidies involves the government paying part of the cost to the firm. This reduces the price of the good and should encourage more consumption. A subsidy shifts the supply curve to the right.
          • A subsidy works very much like opposite to tax.
      • comment points
        • Subsidy can be expensive as requires tax revenue
          • Opportunity cost of subsidy? could have been spent on education, health etc. is it worth it?
        • Is there an external benefit?
    • information provision
      • since information failure is one of the causes of market failure, information provision is an important tool for correcting market failure.
        • Information provision aims to make consumers realise the true costs of their consumption and try and change their behaviour.
          • Relevance to merit, de merit goods and negative, positive externalities.
          • In most cases information is accompanied by regulations and laws
          • Government also ensures that media advertisers are truthful about claims made about their products, particularly health and beauty products. in this way  it is hoped that consumers will receive truthful and impartial information.
          • If consumers are  more aware of the negative externalities and private costs, they might reduce their consumption.
            • Consumers tend to ignore information and wont be likely to change consumption
      • Comment points
        • Consumers tend to ignore information and wont be likely to change consumption
        • Information may not be understood by consumers.
  • economic effiency - allocative and productive efficiency
    • Market failure where the free market mechanism fails to achieve economic efficiency.

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