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Macroeconomics II –The market system

Market failure

6.1 Introduction

Market failure is the inability of a market to allocate resources in a way
that maximises utility

 Governments may intervene to resolve these shortfalls, giving a mixed
economy

6.2 Public goods

 Problem – some goods (e.g. street lighting, police force) may not be produced
under a market system due to
– Non-excludability (“free-rider” problem)

– Non -rivalry

 Solution – provided by the state, which hopefully benefits from economies of
scale. (Major argument for the need for taxation)

6.3 Externalities

 Problem – important issues may be ignored by the free market
– Negative externalities, social costs – e.g. pollution

– Positive externalities, social benefits – e.g. merit goods below: healthcare,
education, development of renewable energy sources

 Solution – make externalities internal – e.g. “polluter pays” policies, tax on
supply (shift supply curve to the left), regulation on externality levels
 Solution – discourage demand – e.g. indirect taxes on consumption, subsidise
purchase of goods/services that don’t generate negative externalities or that do
generate positive ones

 Direct provision – the government provides the goods/services themselves to
control the externalities generated

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