Market Failure, Externalities, Public Goods, and Economic Indicators

This article discusses market failure, negative externalities, public goods, and economic indicators such as GDP and trade deficit. It also covers protectionism, exchange rates, and the theory of comparative advantage. Examples from New Zealand are used to illustrate the concepts.

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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and services from businesses. Prices in the goods market are determined in such a
way that there is balance between consumer demand and the supply side from
businesses. prices in factor market are set to balance household supply with
business demand.
Figure 3 Circular Flow of Goods and Services
Adapted from (Samuelson & NordHaus, 2004) Prepared by Author
The circular flow of market economy is represented in the diagram above. Consumer
decisions interact with business supply in order to determine the production of goods at the
top, the product market. This determines what is produced.
At the bottom, is the factor market, where business demand meets the supply of labour,
and other inputs in the factor markets below to help determine the wages, rent and interest
payments. Thus, the incomes influence for whom the goods are produced. Competition
among producers to by factor inputs and sell goods most cheaply determine how goods are
produced.
b) ‘Gross Domestic Product’ GDP is a measure of the total output in the economy. GDP
is the measure of the market value of the final goods and services produced by the
country in a given year. Nominal GDP is the GDP of a given country and is measured
at the current, actual market prices. Real GDP is the calculated by adjusting for
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inflation, and is calculated given the prices in a base year. This is done to ensure that
impact of inflation is removed to present a realistic picture of GDP growth.
(Samuelson & NordHaus, 2004)
c) Economic development for a very long time, had been measured in terms of Gross
Domestic Product or the sum total of goods and services produced in a country.
However, as economic data began to be available, the short-comings of a system of
ranking countries based only on their economic performance within a given year
were being noticed.(Bergh, 2008) In order to capture a more qualitative
understanding of a nation’s ability to provide for its citizens or its wealth, more and
more indicators were being developed
d) Bhutan was the first country to measure it’s progress as a nation by the yard stick of
happiness, rather than GDP. Several national and international government bodies
have capitalized on the idea and developed indicators of happiness. Indicators of
happiness, generally, take an all rounded approach and synthesize a variety of
indicators of well being, in order to estimate the Gross Happiness of a country.
(Bergh, 2008)
e) The statistics are gives as follows
Quarter ended December
2016
Quarter ended December
2017
Unemployment 5.3 4.5
Real Production GDP 4.0 2.9
CPI inflation 0.4 1.6
Figure 4 New Zealand Economic Data
Data Source: (The Treasury, Government of New Zealand, 2018) and (Government of
New Zealand, 2018)
f) The Real GDP is still growing. Hence, the economy is in the boom phase or
expansionary phase of business cycles. (Samuelson & NordHaus, 2004)
QUESTION THREE:
a) Protectionism is a wide set of approaches and policies followed to restrict trade
between two countries and does not have a legal definition. (Cheng, 2017).
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Protectionist policies include tariff and non tariff barriers. Free Trade on the other
hand, is the absence of formal any barriers from trade among different regions of
the country.
b) I) A trade Deficit occurs when the money value of the imports of a given country are
greater than the money value of the exports of same country. For example, the
exports of goods from USA to China are smaller in Dollar value than the imports of
USA from China, causing a deficit in the Balance of Trade Position. (Swanson, 2018)
The trade Deficit between USA and China is 43,6 % per cent or near,y half of the total
trade deficit of USA. (Babones, 2018)
ii) the Trade Gap that exists between USA and China is known as the Trade Deficit. For
example, in December 2017, USA has a trade deficit of 53.11 billion Dollars gainst China.
(Swanson, 2018)
iii) Trade wars are series of policy decisions that impose retaliatory tariff and non tariff
trade restrictions as a response to protectionist tendencies by a government. For
example, if the USA imposes tariffs of steel imports from China that China may impose
tariffs on goods imported from USA such as soybean and beef. (Babones, 2018)
c) New Zealand is a partner in the “Comprehensive and Progressive Agreement for
Trans-Pacific Partnership” or CPTPP. This is a Free trade Agreement which was
recently signed by over 11 countries. (Brockett, 2017) (Gleeson, Townsend,
Weatherall, Ranald, & Ranald, 2017)
d) The Theory of Comparative Advantage, given by Ricardo postulates that a country will
benefit from external trade even when it is absolutely more efficient or absolutely less
efficient than other countries in production of every good or service on its own. (Mankiw,
2008)
e) The Exchange Rate of a country is the value of the official currency of a country against
another currency or currency equivalent items like gold. For example, the exchange rate of
New Zealand. A rise in the price of a currency paid in another currency is known as a
appreciation of a currency. (Cherunilam, 2005)
An appreciation of the New Zealand Dollar against any currency implies that the New
Zealand Dollar is now more expensive and that more units of the other currency are
required to buy New Zealand Dollars. Thus, countries that import goods from New Zealand
and make payments to New Zealand will have to pay more. Consequntly, the exporters from
New Zealand will suffer due to an appreciation in the New Zealand Dollar as the foreign
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counterparts who receive the goods from New Zealand will find them to be more expensive.
In a basic supply and demand model, this will reduce the demand of goods from New
Zealand. On the Other hand, those who are importing goods from other countries, the
importer will benefit from the appreciation as the price paid by them for imports will be
lower.
Conversely, the demand for imports will rise. (Cherunilam, 2005)
f) Since September 2017 and for the quarter until December 2017, the New Zealand Dollar
has depreciated by 4.6 % against the US Dollar, by 6% against the Great British Pound, by 2%
against the Australian Dollar, by 3% against the Japanese Yen, and by 4;8 % against the Euro.
(Government of New Zealand, 2018)
g) Aggregate Supply:
The Aggregate Supply of a country is it’s total output at the highest level ‘sustainable
output’ that might be produced without causing instability in the economy. The sustainable
level of output, is also known as the country’s potential output and is the long run output of
the country (Samuelson & NordHaus, 2004) In the short Run, the Aggregate Supply curve is
subject to diminishing returns (in the diagram below, it is represented as AS). In the longer
run AS is completely or almost completely elastic (governed by factors such as population,
natural resource endowments etc.) (represented as “Potential Output” in diagram below)
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Figure 5 Aggregate Supply Curves in Short and Long Run
Adapted by Author from (Samuelson & NordHaus, 2004)
In general, factors affecting the Aggregate Supply curve are:
 General Price Level: The price level determines, the wages, investment demand etc.
An upward movement in the price level will shift the AS curve to the right and a
downward movement will shift it to the right.
 Subsidies and Taxes: Subsidies and taxes affect the disposable incomes of the
consumers and their ability to buy certain goods (for example subsidies on fossil
fuels lead to a higher consumption of fossil fuels). Taxes may raise the price of
certain goods and make them more expensive, leading to a reduction in supply. (For
example, taxation on tobacco will make cigarettes expensive for manufacturers).
Aggregate Demand:
The Aggregate Demand Curve represents the “total quantity of output that is willingly
bought at a general price level”. Aggregate demand is generated as the sum total of the
demand of its four components: (Samuelson & NordHaus, 2004)
 Consumption Demand (C)
 Government expenditure or purchases (G)
 Private Investment Demand(I);
 Total residual of Exports and Imports of the given country known as Net exports (X)
A change in any of the factors will lead to a shift in the AD curve.
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Figure 6 Components of an Aggregate Demand Curve
Adapted by Author from (Samuelson & NordHaus, 2004)
h) If New Zealand is a net exporter then, the total impact will be positive and the AD
curve will shift to the right. If New Zealand is a net importer, then the AD curve will
shift to the left
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Figure 7 Aggregate demand and supply. AD curve shifts to the right.
Source:(Samuelson & NordHaus, 2004)Adapted by Author
i) “Balance of Payments” Accounting refers to a systematic accounting of a country’s
financial transactions with the world, just like a firm’s balance sheet, given a period of time.
The IMF manual on Balance of Payments (BOP) of a country provides a statistic statement of
all the transactions of goods and services and currency between any nation and all the
countries in the world.
Like any firm’s balance sheet, changes of ownership are reflected in the balance sheet, along
with other changes in the economic position resulting from changes in the monetary value
of the gold, Special Drawing Rights given by IMF, and claims that could be made by the
country and it’s liabilities to be paid for the rest of the world.
The components of Balance of Payments are as follows:
Current accounts: These accounts are all the accounts that give rise to or reduce the
National Income. Current Accounts, in general, consist of i ) Value of the Merchandise
Exports and Imports or the export and import of goods to and from abroad ii) Invisible
Exports and Imports or the exchange of services (example outsourcing services) between
the country and the rest of the world. (Cherunilam, 2005)
j) An increase in exports receipts (provided that the currency is not devalued sufficiently)
will lead to a current account credit and tilt the balance of Payments towards a surplus.
There may be a trade surplus too. (Cherunilam, 2005)
k) The term “utu” symbolizes trade reciprocity, in proportion to what was received. Maori
trade largely consisted of a “gift-for a gift” exchange system. ((Ministry for Culture and
Heritage, New Zealand Government, 2012) However, while there was no barter system,
trade was recognized. Travellers would often carry with them the goods that their areas
hasd a comparative advantage in . For example, sea side dwellers would carry fish while
inland vistors while inland visitors would carry potted birds etc. (Maori Info, 2015)
Prior to 1805, whalers would often land at the coasts of New Zealand. Maoris would offer
them food and water ad would. In exchange, receive some manufactured goods such as
clothing and muskets. (Museum of New Zealand, 2015). These were some of the first steps
into trading by Maoris which became more sophisticated later on. (Easton, 2010).
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