` Market Failure
LO6 AC6.1
ASSESSMENT CRITERIA AND INDICATIVE CONTENT
2
LO6: Evaluate the effectiveness of economic policies in resolving contemporary economic
challenges.
AC6.1 Explain and analyse the causes and economic implications of market failure, including
externalities and information asymmetry.
• Definition of Market failure and its causes and implication for the economy
• Concepts of consumer and producer surplus and deadweight loss using diagrammatical
illustration.
• Meaning and characteristics of public, quasi-public, merit and demerit goods.
• Externalities in Consumption and Production in relation to social efficiency using diagrams.
• Imperfections in the market: Missing information, asymmetric information, adverse selection
and moral hazard.
Key Reading for Students:
Smith, P. (2019), OCR A Level Economics, 4th Ed. Hodder
Education, London – Chapters 8 & 9 Market Failure
OCR A Level Economics (4th Edition) - Record details - EBSCO Discovery Service
Merit and Demerit Goods
It is a vaccination service
It is known as a merit good
Merit goods are often services
The government thinks that merit goods provide positive benefits
for both the people that use them and society as a whole
Why in this case?
They should be consumed to a greater degree
Because the market doesn’t provide enough (because there is not
enough demand) the government has to step in
How can it supply more?
It can provide them directly
It can subsidise them so that there is no direct cost to the consumer
Why no direct cost?
Because they pay indirectly through taxes
Merit goods are products that
society values and judges that
society should have regardless of
whether an individual wants
them – they are under
consumed by society because
the benefits of the good are not
fully appreciated by society
Merit goods
More Merit Goods
Why is this a merit good?
If the government didn’t provide schools would everyone pay for it?
Maybe you would be too poor to afford it and leave your kids at home
The market would not provide enough so government has to step in
Education and healthcare in
the UK would not be produced
in sufficient quantity by a free
market because consumers
would not want to purchase
enough of these services. This
is because they may not have
enough knowledge to assess
the true private benefits.
Private benefit
– the benefit to
private
businesses or
individuals
Why are these Merit Goods?
Would government
provide or
subsidise these
services to the
same extent?
Some will be more
important than others and
will gain more funding
Merit goods tend to have positive externalities -
that is they have positive benefits to those not
involved in the transaction
The social benefits are greater than the private
benefits
In the case of the library the benefit to a person
(private benefit) is to become better educated
The external benefits are that the economy may
grow because the labour force is better educated
and more efficient
The social benefit is both of these put together.
Private benefit – the
benefit to private
businesses or
individuals
Social benefits = private benefits plus
external benefits
External benefit–
the benefit to the
third party not
involved
Positive externalities
It is fast food
It is known as a demerit good
The government thinks that demerit goods are bad for both the
people that use them and society as a whole
Why?
They should be consumed to a lesser degree
Because the market provides too much (there is too much
demand) the government decides to step in
How can it reduce supply?
It could ban them
It could educate consumers on the harm
Anything else?
It could put a tax on them
How would that work?
Demerit goods are those
products that society deems as
bad for you - again a value
judgement is being made
Demerit goods
Why are these Demerit Goods?
If government chose
tax to reduce alcohol
consumption would it
tax the same % as
cigarettes?
Cigarettes may be
seen as more
harmful than
others and have
higher taxation
Information failure: demerit goods
Demerit goods are those products that society deems as bad for you - again a value judgement is
being made
Smoking, Drugs, Gambling, foods that make you obese are all examples of demerit goods in
western society
• A product that the government believes
consumers overvalue because of imperfect
information.
• A demerit good is ‘socially undesirable’ and
‘worse’ for a consumer than the consumer
realises e.g. alcohol
• Government will seek to reduce
consumption of demerit goods
Watch this mjmfoodie video
Public goods
Private goods vs Public goods
Private goods are the opposite to public goods so if we understand what they are first
then we will understand what public goods are
Businesses in the private sector provide private goods
Characteristics of private goods
Private goods are excludable - consumers of private goods can be excluded from
consuming the product if they are not willing or able to pay for it
For example - a ticket to the theatre or a sports event or a meal in a restaurant - If
you don’t pay, you don’t consume and benefit from the good or service!
Private goods are rival
One person's consumption reduces the amount left for others to consume
Scarce resources are used up in producing and supplying the good or service
There is an opportunity cost
Private goods are rejectable
Private goods can be rejected
Public goods
Pure public goods have three main characteristics:
Non-excludability:
The benefits of public goods cannot be confined to
those who have paid for it
Non-payers can enjoy the benefits of consumption at
no financial cost to them
Non-rivalry in consumption:
Consumption of a public good by one person does not
reduce the availability of a good to others
In other words, if the good is provided for one person it
must be provided for others
Non-rejectable
If a public good is provided, we cannot avoid it
Pure Public Goods
Pure public goods are also known as collective consumption goods
• National Defence Systems
• Sewage and Waste Disposal Systems
• Lighthouse Protection
• National Rail Safety Systems
• Street Lighting
The market would not provide these so they are called full market
failure or a missing market
Why would the market not provide?
Free riders!
The free rider problem
• If provision of public goods was left to the free market, there would be
complete market failure (none would be provided at all).
• This is because of their non-excludability – if you cannot be excluded
from the benefit of the good, where is your incentive to pay for the good?
• A free rider is someone who receives the benefit of a good, but does not
pay for it. Their consumption depends on others paying for the good.
• For example, you may be able to increase your economic welfare by
riding a train without paying for a ticket.
The free rider problem
• In a pure free market economy, national
defence, policing and a judiciary are unlikely
to be provided, because they could not be
sold to benefit individual citizens.
• They can only be provided by a government
with the power to force citizens to pay taxes
to fund these services.
• There is no equilibrium point where demand
and supply intersect.
Quantity
Pr
ic
e
S
D
For many other public/quasi-public goods, there would be
dramatic underprovision.
For example, it may be possible to persuade residents of an
affluent street to pay for streetlights or road maintenance, as it
would be to their benefit.
However, residents in other, poorer areas would not be able to
pay the required cost and therefore the good would not be
provided.
Which one is the odd one out?
The benefits of water
filtration systems
The enjoyment of a
fireworks display
The light for passing
ships
Chilling out on the
beach
Semi-Public (Quasi) Public Goods
These are products that are public in nature, but do not exhibit fully
the features of non-excludability and non-rivalry
They may become rival e.g. at peak times when congestion occurs
On grounds of equity (fairness) the government may provide these
goods directly and finance them through general taxation
There is an element of excludability or rivalry in consumption
Examples might include:
Motorways and major roads
Parks
Terrestrial television (public service broadcasting)
Police Force protection
Galleries and Museums
Airwaves
Why does the state provide public goods?
Because public goods are non-excludable, profit-seeking firms will not provide
them.
The non-excludability of a public good encourages some consumers to avoid
payment and become free riders.
Firms cannot collect all the revenue needed to supply the public good and make a
profit.
The state/government provides them
On grounds of equity – so that people on all levels of income can have access to
them
Provision on grounds of need rather than ability to pay
On grounds of efficiency
Easier to provide them collectively
Economies of scale from providing to all
To overcome the free-rider problem
To correct for market failure – the failure of the market to provide sufficient
public goods (partial market failure)
Mini Review
Without looking at your notes tell me…
• What are the characteristics of public goods?
• Why would public goods be under-provided or
not provided by the market mechanism?
• What are quasi-public goods ?
• Extension: What problems would Governments
face in providing public goods?
intostudy.com/intomanchester
Please attempt the quizzes on the VLE for
week 1.5 if you haven’t done so already!

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