Market Failure, Externalities, Public Goods, and Economic Indicators

Question 1
1. Market Failure
Market Failure is regarded a situation wherein the market mechanism (of supply and
demand) does not capture the total costs of the production of economic goods. A market
failure means that a market has not been functioning efficiently. (Mankiw, 2008)
Government interventions in the form of quotas, subsidies, taxes etc, are required to
remedy market failure.
 Negative Externalities: In many cases, the society pays for the costs of producing
private goods. For example, the pollution resulting from the production of goods
have negative effects which may cost the society. The costs are not borne by the
producers producing the goods. Hence, government intervention is required.
(Dollery & Wallis, 1999)
 Public Goods: Goods such as health care, street lighting etc. Are consumed by all but
are not demand by individuals. The private sector may be able to provide these
goods efficiently, at affordable costs. For example, public health care is provided as
government intervention against market failure of unaffordable health care costs.
(Dollery & Wallis, 1999)
 Invisible Hand Promotion of Equality: The invisible hand may create several problems
such as uneven competition. (Dollery & Wallis, 1999) Policies relating to solve market
failures seek to achieve greater equality. The goal of a modern welfare state is
promote greater equality. Hence, the government provides incentives and
disincentives to promote equality. For example, the government may intervene in
promoting the development of the Aboriginal and Maori communities by provisions
of free health care, education etc. (Mankiw, 2008)
An Externality represents the difference between “Marginal Private Cost” (MPC) and the
“”Marginal Social Cost(MSC). Marginal Private costs are costs incurred directly by the
producers in the production of the last unit of the given good or service, as defined by
according to Lipsey & Chrystal, 2015 while Marginal Social Cost is the cost that was borne by
the society in the process of production of the last unit of the good or service. The Marginal
Social Cost (MSC) is the valuation of the impact borne by the society in the production of

that marginal good or service. The production of goods or services has an effect on the
social good. Positive Externalities would lead to a net increase the social good and would be
beneficial to the public, overall. Conversely, a negative externality would reduce the social
good and have a harmful effect, causing inconvenience to the public (Lipsey & Chrystal,
2015)
The effects of negative externalities can be depicted in the diagrams given below:
Figure 1 Negative Externalities and the Loss of Social Good. Adapted from (Riley, 2005)
In Figure1, Triangle ABC represents the loss of social good or social deadweight loss
(Marginal Private Benefit - Marginal Social Cost). Marginal Private Benefit is the utility of the
consumer from consuming a good or service. Both of these costs are Marginal Cost Curves
and Figure 1 is simply a supply and demand analysis with the marginal cost of the society
and individual producer as two parts of the total Marginal Cost.
c) One of the most prominent government interventions used to curb the negative
externalities of the use of tobacco products is taxation. Generally, the healthcare costs
resulting from tobacco products such as cigarettes, is not factored in the cost of production
of cigarettes. Taxation can help solve this market failure. The government can tax tobacco
which will raise the cost of production of tobacco and tobacco products such as cigarettes.
This will help the demand decrease and the demand curve will shift left. (Mankiw, 2008)
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d)
Figure 2 Supply and Demand for Tobacco Products (Cigarettes) due to taxation
In the diagram above, demand falls from DD to D’D’.
e) Public goods are goods or services are made available to all or several members of the
society, either by the government or by private markets. The defining characteristics of
punlic goods are that they are “non Excludable”, “non Rival”. Non Excludable refers to the
characteristic that members of the society cannot be singled out to be excluded from the
usage of the goods.: “Non rival” refers to the characteristic that the consumption of a good
or service by one consumer will not reduce the availability of the same good or service for
another consumer. For example, a street lighting is a non excludable good and service. Any
individual who commutes on a street cannot be excluded from the usage of the lighting and
the usage of a street lighting by one consumer will not reduce the usage of street lighting by
another consumer.
f) Public Goods often, suffer from the Free Rider problem i.e. public goods are often used by
all but not paid for by everyone, For example, street lighting provided by the city
government is used by all, even by those who pay the city taxes and by those who don’t.
Hence, there are free riders. (Lipsey & Chrystal, 2015)
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Public goods are usually, consumed by all individuals (they are non excludable) but
demanded by none i.e. there is not individual who demands the construction of street
lighting for their own usage. It is a social good. As a result, the private sector may not have a
demand for them. Hence, they are built by the government. (Chauhan, 2015)
g) Tragedy of Commons, a theory propounded by Garrett Harding, postulates that when
individuals are allowed free use of any common resource, they would tend to exploit the
resource to maximize their own good. (McClintock, 2017) An example of such behaviour in
New Zealand is the excessive fishing in the water resources in an around New Zealand
(Morgan & Simmons, 2011). Excessive fishing may cause the extinction of some crucial fish
species like the blue cod. (McClintock, 2017)
h) Maori business are rooted in the Maori culture and may differ in the following way:
(Ministry of Education, Government of New Zealand, 2013)
 Maori businesses are oriented towards a “multiple bottom line” and spiritual,
cultural, and environmental goals are outlined, apart from economic goals. This is
not very different from the idea of the “triple bottom line of business sustainability.
However, spiritual goals are not a part of any business sustainability effort.
 Maori businesses, may, very often be formed to develop and profit from Maori
common resources such as Maori forests, rivers etc. Hence, it is possible that most of
the resources used in such businesses will follow old age traditions and tried and
tested Maori processes. For example, the fruits sold by a Maori business may be
organic due to the lack of usage of any pesticides.
 Profit may not be the central goal of Maori businesses. The central goals may be
diverse such as promotion of Maori culture etc.
QUESTION TWO
a) The Circular Flow of Goods and Services (given in the diagram below) is a depiction of
the complex interdependent relationships between supply and demand in the product
and factor markets which are interconnected by way of the market mechanism. The
Circular flow shapes the solutions to the economic problems of what, how and for
whom to produce.
 Consumers purchase goods and make available factors of production (land, labour,
capital, entrepreneur) while businesses sell goods and purchase these factors of
production from households (and other businesses). The income generated from
sale of labour and other inputs in the production process id used to purchase goods
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