Market failure economics notes

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MARKET FAILURES
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Market Failures
Economics is significant in explaining the complex contemporary issues. It further
describes the economic behavior of different economic issues. It requires social intervention to
address the market failures where the market fails to correct itself. In this case, the government
intervenes using various policy measures. Therefore, a clear understanding of the appropriate
policy measures can help to address the existing economic problems like air pollution.
Air pollution
Air pollution is the real world problem in the second diagram. Firms and individuals
participate in the air pollution. For example in the picture, the person smoking causes air
pollution. Pollution affects the surrounding environment (Harrison 2001). It is detrimental to the
surrounding. Environmental interference not only causes environmental concerns like global
warming, but it leads to health complications. It negatively affects the individuals around. For
example, those people in the picture feel that their salmon is smoky. Air pollution is a source of
market failure. It causes negative externalities which are not reflected in the prices. Hence, it
leads to market failure.
Economic Explanation for the Existence of Air Pollution
Different factors cause air pollution. The major air pollutants can either be classified as
primary or secondary sources (Reitze 2005). Direct sources like the production of carbon into the
air is an example of a primary factor. On the other hand, the interaction of primary factors with
other elements which cause pollution are the secondary sources. The conventional sources of air
pollution are the primary factors. Burning Fossil fuel causes a higher percentage of air pollution
compared to other factors. Fossil fuel produces sulfur dioxide that is harmful. Additionally,
agricultural activities produce gases like ammonia which are unhealthy. Furthermore, industries

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emit toxic substances into the air. Moreover, consumption of harmful substances like a cigarette
as shown in the picture is a source of air pollution.
Government Policies to Address Air Pollution
The government can enforce the regulation. Regulations on the limit to which the air can
pollute are effective in reducing air pollution. For example, the EU has a regulation of the Clean
Air Act (1956) which reduced pollution in cities like London (Knight 2006). It achieved this by
banning the burning of coal in major cities.
Also, the government can use tax measure to address pollution. The tax raises the price of
goods (Goetz & Berga 2006). Increased tax can reduce the demand for the targeted product. For
example, increasing taxes on cigarettes would cause the number of cigarettes consumed to
reduce as demand decreases. The purpose of the tax is to make the consumers and producers to
cater for the full social cost of pollution as shown below.
The tax shifts the supply of cigarettes from S1 to S2. Consumers are forced to pay for the
external cost of pollution which is reflected in the reduction of quantity consumed from Q1 to Q2.
It leads to reduction in pollution as the consumers pay a higher price of P2 from P1. Therefore,
S2=Social Marginal
Cost S1=Social Marginal
Cost
Demand
Q1Q2
P2
P1
Quantity of Cigarette
Price
Effect of a tax

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production is efficient where social marginal cost is equal to marginal social benefit. Thus, the
government will achieve its aim for a reduction in air pollution.
In summary, air pollution is real world problem. It causes market failure. The
externalities caused by smoking cigarettes are not reflected in the market prices. However, the
government can apply tax and regulation policy to reduce air pollution.

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Reference List
Goetz, R.-U., & Berga, D. (2006). Frontiers in water resource economics. New York, Springer
Science+Business Media.
Harrison, R. M. (2001). Pollution: causes, effects, and control. Cambridge, Royal Soc. of
Chemistry.
Knight, D. J. (2006). New EU regulation of chemicals: REACH. Shrewsbury, Rapra Technology.
Reitze, A. W. (2005). Stationary source air pollution law. Washington, D.C., Environmental
Law Institute.