Understanding Covid-19's Economic Impact: Market Failures & Imperfections, Lecture notes of Economics

Download Understanding Covid-19's Economic Impact: Market Failures & Imperfections and more Lecture notes Economics in PDF only on Docsity! Why Markets Fail? The Economics of Covid-19 Part 1: Markets and Market Failures Jim Dana Northeastern University Markets are Efficient Markets work well in many settings. 1. Costs are minimized 2. Consumers pay only the economic costs of the goods they buy 3. Producers or firms are adequately compensated for capital investments and risks 4. The allocation of goods is efficient, or Pareto optimal When economists say that a market works well, or is efficient, they mean that it results in a Pareto optimal allocation: there is no way to make everyone better off by altering the decisions that markets make. But clearly markets do not always work well. For example, many workers are unemployed in a recession. What about Inequality? In addition to market failures, maximizing surplus may not be the only objective. Inequality is not a market failure as we define it. But inequality can lead to political unrest and uncertainty, which are inefficient. And if equality is something we all value (are willing to pay for), then increasing equality can be efficient. 1. Market Power • Firm’s with market power (monopoly) set inefficiently high prices • Output is inefficiently low • Some consumers don’t buy even though they value the good more than its cost • Firm’s with market power may also make other inefficient decisions • Product quality • Privacy • Innovation • Government antitrust policy and consumer protection policy limits market power. 2. Asymmetric Information • Incomplete information, also called hidden information or adverse selection. • Ability • Health Status • Quality (durability) • Imperfect information, also called hidden action or moral hazard. • Effort • Risk taking and precaution taking • Quality (safety) 3. Externalities • Consumption sometimes benefits individuals besides the purchaser, and sometimes harms individuals besides the purchaser. • Positive externalities: • Fire sprinklers, vaccinations, and other precautions • Phones and other network products • Beautification • Negative externalities: • Pollution • Noise • Risky behavior 4. Public Goods • Some goods are freely available to everyone (or cheaply available) such as information, air, national defense, street lights and lighthouses, roads, and many safety investments. • These goods are non-excludable and nonrivalrous goods. • Public goods are not supplied efficiently by markets. • Examples • Lighthouses, street lights, national defense • Information Mechanisms that Mitigate Externalities and Public Good Inefficiencies • Property rights, such as copyrights and patents. Including public and private enforcement systems. • Fees/Tolls/Taxes or Subsidies/Rebates • Regulation: Process/Behavior Standards (and fines) • Regulation: Performance Standards (and fines) • Government Provision