Archive for the 'Market failure' Category

Aug 24 2015

The tragedy of the commons in the Arizona desert

A common access resource is one that is non-excludable but rivalrous: anyone can access it and use it but doing so reduces the benefits the resource can provide to others in society. Common examples are pastureland that is shared by cattlemen, fish in the open ocean and the atmosphere itself, which the more it is used as a sink for toxic air pollutants, the worse human health becomes.

In the American West, examples of common access resources abound, leading to several tragedies of the commons, the problems arising from individuals over-using a common resource for their own gain at the expense of others in society whose ability to benefit from the resource is diminished.

Lately farms have been popping up deep in the Arizona desert. Not because there is lots of water in the desert, which of course, there is not; rather because the water that lies under the desert floor is not managed by anyone and is a pure common access resource. Anyone is allowed to use as much of it as they want without any regulations regarding its use!

The story below from Marketplace sheds some more light on this story.

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Nov 19 2014

Efficiency and Market Failure in “Anchorman”

As a follow up to my recent post, A Video and Audio Introduction to Market Failure, I plan to introduce the diagrams we use to illustrate and analyze negative and positive externalities and the inefficiency arising in the markets for certain goods. My fellow Econ Video Lecturer, Mr. Clifford, provides a great introduction to these diagrams in his video, EconMovies 7: Anchorman. We’ll watch the video below before beginning our notes on the subject today! Enjoy!

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Nov 17 2014

A video and audio introduction to Market Failure

Each of the following videos or audio clips illustrate an example of a market failure. Watch or listen to each and answer the questions that follow:

Stories #1 and #2: “Cowboy City” and “Toxic Cotton”

Stories #3 and #4: “Trash Island” and “Nauru is Dead”

Story #4: “E-waste”

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Story #5 “Why is there no Ebola vaccine?”

Story #7: Sweatshops and story #8: Toxic chemicals (watch up to 11 minutes)

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Discussion Questions:

  1. Which of the stories above is about public goods, or goods which would not be provided at all if left entirely to the free market? Explain.
  2. Which of the stories above is about demerit goods, or ones which would be over-provided by the free market due to their negative effects on the environment or human health? Explain.
  3. Which of the stories above is about merit goods, or ones which are provided by the free market, but at a quantity below which is socially optimal due to the fact that they create spillover benefits for society as a whole.
  4. Which of the stories describes a good or goods which the government currently regulates the production of? Which goods does government currently NOT regulate the production of?
  5. What makes each of the stories above examples of market failure?

12 responses so far

Nov 13 2014

Market failure blog post activity and student-created study guide

Over the years I have written many posts on this blog about market failure. The purpose of this activity is for students to re-visit some of these posts, reflect on different types of market failure, and then complete a short survey in which they demonstrate their understanding of the topic.

With the results from the survey, we will have assembled a comprehensive spreadsheet of all the different types of market failure we study, including definitions, examples, graphical representations and possible government responses. This document can then be used for review by Economics students studying for a market failure test.

First, you must get into five groups and each group must read a couple of blog posts about their assigned market failure type.

Group 1: Public Goods:

Group 2: Positive consumption externalities:

Group 3: Positive production externalities:

Group 4: Common Access Resources and the Tragedy of the Commons

Group 5: Information Asymmetry
Group 6: Income Inequality

Once your group has read and discussed the blog posts you were assigned, work together to complete the following form. Only click submit once all questions have been answered!

Google Form – Market Failure Definitions and Examples

Once each group has submitted the form, the results can be viewed publicly here:

Market Failure Definitions and Examples Study Guide

One response so far

Mar 04 2013

Monopoly prices – to regulate or not to regulate, that is the question!

Competitively Priced Electricity Costs More, Studies Show – New York Times

The problem with monopolies, as our AP students have learned, is that a monopolistic firm, left to its own accord, will most likely choose to produce at an output level that is much lower and provide their product at a price that is much higher than would result from a purely competitive industry.Regulated Monopoly A monopolist will produce where its price is greater than its marginal cost, indicating an under-allocation of resources towards the product. By restricting output and raising its price, the monopolist is assured maximum profits, but at the cost to society of less overall consumer surplus or welfare.

Unfortunately, in some industries, because of the wide range of output over which economies of scale are experienced, it sometimes makes the most sense for only one firm to participate. Such markets are called “natural monopolies” and some examples are cable television, utilities, natural gas, and other industries that have large economies of scale. (click graph to see full-sized)

Government regulators face a dilemma in dealing with natural monopolistic industries such as the electricity industry. A electricity company with a monopoly in a particular market will base its price and output decision on the profit maximization rule that all unregulated firms will; they’ll produce at the level where their marginal revenue is equal to their marginal cost. The problem is, for a monopolist its marginal revenue is less than the price it has to charge, which means that at the profit maximizing level of output (where MR=MC), marginal cost will be less than price: evidence of allocative inefficiency (i.e. not enough electricity will be produced and the price will be too high for some consumers to afford).

Here arises the need for government regulation. A government concerned with getting the right amount of electricity to the right number of people (allocative efficiency) may choose to set a price ceiling for electricity at the level where the price equals the firm’s marginal cost. This, however, will likely be below the firm’s average total cost (remember, ATC declines over a WIDE RANGE of output), a scenario which would result in losses for the firm, and may lead it to shut down altogether. So what most governments have done in the past is set a price ceiling where the price is equal to the firm’s average total cost, meaning the firm will “break even”, earning only a “normal profit”; essentially just enough to keep the firm in business; this is known as the “fair-return price”.

Below AP Economics teacher Jacob Clifford illustrates and explains this regulatory dilemma. Watch the video and see how he shows the effect of the two price control options on the firm’s output and the price in the market.

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The article above examines the differences in the price of electricity in states which regulate their electricity prices and states that have adopted “market” or unregulated pricing, in which firms are free to produce at the MR=MC level:

“The difference in prices charged to industrial companies in market states compared with those in regulated ones nearly tripled from 1999 to last July, according to the analysis of Energy Department data by Marilyn Showalter, who runs Power in the Public Interest, a group that favors traditional rate regulation.

The price spread grew from 1.09 cents per kilowatt-hour to 3.09 cents, her analysis showed. It also showed that in 2006 alone industrial customers paid $7.2 billion more for electricity in market states than if they had paid the average prices in regulated states.”

The idea of deregulation of electricity markets was that removing price ceilings would lead to greater economic profits for the firms, which would subsequently attract new firms into the market. More competitive markets should then drive prices down towards the socially-optimal price, benefiting consumers and producers by forcing them to be more productively efficient in order to compete (remember “Economic Darwinism”?). It appears, however, that higher prices have not, as hoped, led to lower prices:

“Since 1999, prices for industrial customers in deregulated states have risen from 18 percent above the national average to 37 percent above,” said Mrs. Showalter, an energy lawyer and former Washington State utility regulator.

In regulated states, prices fell from 7 percent below the national average to 12 percent below, she calculated…

In market states, electricity customers of all kinds, from homeowners to electricity-hungry aluminum plants, pay $48 billion more each year for power than they would have paid in states with the traditional system of government boards setting electric rates…”

That $48 billion represents higher costs of production for other firms that require large inputs of energy in their own production, higher electricity bills for cash-strapped households, and greater profits and shareholder dividends for the powerful firms that provide the power. On the bright side, higher prices for electricity should lead to more careful and conservative use of power, reducing Americans’ impact on global warming (since the vast majority of the country’s power is generated using fossil fuels).

Here arises another question? Should we be opposed to higher profits for powerful electricity firms if their profits result in much needed energy conservation and a reduction in greenhouse gas emissions? An environmental economist might argue that if customers are to pay higher prices for their energy, it might as well be in the form of a carbon tax, which rather than increasing profits for a monopolistic firm would generate revenue for the government. In theory tax revenue could be used to subsidize or otherwise promote the development and use of “green energies”.

Whether customers paying higher prices for traditionally under-priced electricity is a good or bad thing depends on your views of conservation. But whether higher profits for a powerful electricity company are more desirable than increased tax revenue for the government are beneficial for society or not seems clear. If we’re paying higher prices, the resulting revenue is more likely to be put towards socially desirable uses if it’s in the government’s hands rather than in the pockets of shareholders of fossil fuel burning electricity monopolies.

Discussion Questions:

  1. Why do governments regulate the prices in industries such as natural gas and electricity?
  2. Why would a state government think that de-regulation of the electricity industry might eventually result in lower prices in the long-run?
  3. Why, in reality, did the price of electricity in unregulated electricity markets ultimately increase so much that consumers in the market states paid billions of dollars more than in regulated states?
  4. What industries besides that for electricity share characteristics that might qualify them as “natural monopolies”? Which of the industries you identified should be regulated by government, and WHY?

238 responses so far

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