Market Failure, Public goods and externalities

Market Failure 

• Occurs whenever a market, or the complete absense of a market, leads to a complete misallocation of resources 
• With some market failures, markets do not exist, but they function badly 
• e.g. Markets produce too little of a merit good (health care) and too much of a demerit good (tobacco or crack cocaine) 

• Public goods and externalities are examples of markets failure resulting from the complete absense of a market - problem of missing markets
• With a public good (light house) the market may just not exist 
• Incentive function of prices breaks down
• impossible to exclude free-riders 

Pure public goods - National defence and police - impossible to exclude 'free-riders'

Non-pure public goods - street lights, tv, radio, lighthouses - methods can be devised for converting the goods to private goods by excluding 'free-riders' by charging them for use

Most goods are private goods, possessing 2 important characteristics:

• The owners can excerise private property rights - preventing other people from using the good or consuming its benefits - excludability 
• Benefits available to other people 

Public good however do not possess these characterists - it is non-excludable and non-rival and therefore this leads to market failure 

• Special type of public good or public 'bad' which is 'dumped' by those who produce it on other people (third parties) who receive or consume it, whether they choose to or not
• As with the public goods such as national defence, the key feature of an externality is that there is no market in which it can be bought or sold
• Since they are produced and recieved outside the market, externalities provide another example of a 'missing market'
• Externalities provide example of the 'free-rider' problem
• The provider of an external benefit (or positive externality) such as a beautiful view, cannot charge a market price to any willing free-riders who enjoy it
• While the unwilling free-riders who recieve or consume external costs (or negative externalities), such as pollution and noise, cannot charge a price to the polluter for the 'bad' they reluctantly consume 

THIRD PARTY COST OR BENEFIT