Market Failure and Policy: France's Ban on Petrol and Diesel Cars

This report analyzes France's policy to phase out petrol and diesel vehicles by 2040, focusing on the economic rationale behind the decision. It identifies climate change and fossil fuel subsidies as market failures, explaining how the policy aims to correct these issues. The report examines the impact of the policy on complementary goods like petrol and diesel, as well as substitutes like electric vehicles, using graphical representations to illustrate market dynamics. It also discusses the implementation and effectiveness of the policy, considering factors like the timeline, production capacity, and the role of subsidies. The conclusion highlights the potential social benefits and France's commitment to the Paris Climate Accord and phasing out fossil fuel subsidies.

Understanding the French Policy
to Phase Out Petrol and Diesel
Vehicles
October 10
2017
The French President recently announced a decision to phase out
petrol and diesel vehicles in France by 2040. This paper explores the
decision from the point of view od addressing market failures. It also
provides an analysis of the decision from the point of view of impact
on complementary goods and sunstitues and examines the ffectivess
of the policy.
Addressing Market
Failures

Contents
1. Introduction.........................................................................................................................................1
2. 2. Market Failure.................................................................................................................................1
3. Part Two: The Impact and Effectiveness of the Policy.........................................................................4
3.1 Effects on Other Markets...................................................................................................................4
3.2 Implementation and Effectiveness of the Policy................................................................................7
4. Conclusion...........................................................................................................................................7
Bibliography................................................................................................................................................8
Diagram 1 Negative Externalities: Loss of Social Good............................................................................3
Graph 1 Joint Demand for Fossil Fuels and Fossil Fuel Run Vehicles........................................................5
Graph 2 Cross Elasticity of Electric Combustion Engines versuns Petrol Diesel Combustion Engines......6

1. Introduction
President Macron announced in July that France will phase out its petrol and diesel
vehicles by the year 2040. This announcement comes shortly after the Paris Climate
Agreement was signed, to which France is a signatory. This paper examines climate
change as a market failure and discusses the effectiveness of this policy in addressing this
market failure. This paper also addresses another form of market failure – fossil-fuel
subsidy. The policy is also discussed in the contet of sunsidies.
2. 2. Market Failure
A market failure is a situation when the market mechanism fails to capture all the costs of
producing economic goods. (Stern 2007) A market failure implies that a market is not
functioning efficiently. The policy described in the article has been announced to deal
with the failure called ‘climate change’. This a domestic policy intervention by France so
that France can fulfil its commitment towards the Paris Accord. Climate change has been
described as a ‘market failure’ because the economic systems do not account for the
harmful effects or ‘negative externalities of climate change’. (Stern 2007) Petrol and
diesel vehicles emit Green House Gases (GHG) and these emissions have externalities in
the form of climate change. Climate change entails extreme weathers, global warming
and more. Arrow calculated the economic costs of climate change and concluded that the
world is better off investing in new climate friendly technologies and mitigation efforts
since the benefits of such investment outweigh its costs. (Arrow 2007) Countries measure
economic growth without accounting for the negative externalities of climate change to

the environment and public health and consequently, the costs are borne by the society in
the form of the costs relating to natural disasters, healthcare costs etc. (Stern 2007)
‘Negative externalities’ or ‘diseconomies’ are mathematically represented as a (negative)
deviation of “Marginal Private Cost” (MPC) from the “Marginal Social Cost”. According to
Lipsey & Chrystal, (2011) “Private costs are those costs that are incurred by parties that are
involved directly in the Economic activity” and “Social costs are those costs that are borne by the
society” Hence, Marginal Private Costs refer to the private producer’s cost of the last producing
the last unit produced or providing services to the last consumer serviced. Producers will only
price goods according to ‘willingness to pay’ of consumers. Hence, the responsibility of negative
externalities can also, be transferred to consumers. The ‘Marginal Social Cost’ is a valuation of
the impact borne by the society in the production of the last unit of good or services. Negative
externalities decrease the social good i.e. they have harmful effects or cause inconvenience to the
public, in general. (Lipsey and Chrystal 2011). The diagram given below depicts negative
externalities and the ‘loss of social good’ resulting from the externalities produced by petrol and
diesel cars. The Marginal Private Costs in are the cost of producing the cars. The deadweight loss
is the difference between the two. (Riley 2005). The loss of social good is the loss of efficiency
and this loss of efficiency is calculated a ‘deadweight loss’.

Diagram 1 Negative Externalities: Loss of Social Good
Prepared by Author. Source: (Riley 2005)
Climate change is a result of market failure since the producers of negative externalities do no
bear the full costs and policy intervention is required to correct the possible harmful effects of
climate change. If countries were made to face the negatives effects of climate change
proportionate to their carbon emissions, then it would be the ideal response to the problem as
countries would have acted to reduce their emissions. (Stern 2007) Some of such policy
interventions include ‘carbon pricing’ and ‘emissions trading’. (Arrow, 2007) In the given
example, policy change has been used to seek technological intervention i.e. it is hoped that by
phasing out inefficient technology and replacing it with more efficient technology, the market
failure of climate change can be corrected. In this context, more efficient technology would
imply any technology that can replace the vehicles with considerably fewer emissions. For
example, electric combustion run vehicles or electric cars are considered to be more carbon
efficient.(Chrisafis & Vaughan, 2017)

The prime reason for the existence of policy levers such as carbon pricing is that they provide an
impetus to technological innovations to reduce the social costs of climate change. France has
pledged to reduce its carbon emissions. (United Nations Framework Convention For Climate
Change 2017) Climate and these policy interventions drive the market to pay for the social costs
or impose checks (caps) on the negative externalities that result from economic activity.
Additionally, they provide structures so that those activities that cause these social
‘diseconomies’ or negative externalities would compensate for it. (Samuelson and Nordhaus
2004)
Another form of market failure in this example is the subsidies given for fossil fuels, here petrol
and diesel. (Stern 2007) Fossil fuels can also be considered as market failures since the costs of
subsidies are borne by tax payers who may or may not avail subsidies in equal amount of their
consumption of petrol and diesel.
3. Part Two: The Impact and Effectiveness of the Policy
The policy intervention announced related to investment in a new technology (United Nations
Framework Convention For Climate Change 2017) i.e. electric vehicles to replace the older
technology i.e. petrol and diesel run vehicles. However, petrol and diesel run vehicles are not just
goods but products that a part of the automotive industry with varied allied markets. Key among
them are the market for fossil fuels and electric car.
3.1 Effects on Other Markets
a) Effects on Complementary Goods:
Petrol and diesel are complementary goods to petrol and diesel combustion vehicles.
(Gravelle and Rees 2005) Hence, the reduction in demand and supply of such vehicles will

cause a decrease in demand for petrol and diesel itself. As the demand for petrol and diesel
decreases, the negative externalities of petrol and diesel (i.e. externalities pertaining to Green
House Gas Emissions and externalities pertaining to subsidies) will decrease. This will lead
to high social benefits which may off set the additional costs, if any, that the society may
incur due to the introduction of the new technology.In the diagram below, the demand for
fossil fuels (here taken exclusively as Petrol and Diesel) is assessed, given the demand for
Petrol and diesel cars.
Graph 1 Joint Demand for Fossil Fuels and Fossil Fuel Run Vehicles
b) Impact on Electric Car Market
Commercial car owners can produce cars by varying the engine of the car. (Chrisafis &
Vaughan, 2017) Consumer can choose between the petrol and diesel cars and electric cars. i.e
petrol and diesel combustion engines and electric combustion engines are substitutes. (Gravelle
and Rees 2005) As the demand for electric engine vehicles increases, their average costs will

hopefully reduce and the prices of electric vehicles and petrol and diesel run vehicles will begin
to converge. As the average costs reduce, the price will reduce too, thereby increasing the
demand for electric vehicles further. In the diagram below, it is assumed that future consumers
will either choose from the petrol or electric vehicle. The diagram depicts the cross elasticity of
demand between electric vehicles and fossil fuel run vehicles.
Graph 2 Cross Elasticity of Electric Combustion Engines versuns Petrol Diesel Combustion
Engines.
Source: Prepared by Author
Consumers will substitute petrol and diesel cars with electric cars only if their personal marginal
benefit from an electric car is equal to or higher than the petrol or diesel run cars. Thus, the
electric car must be either equally cost effective or more cost effective than the petrol or diesel
engine car. This may require subsidization of electric cars. (Reuters 2017)

3.2 Implementation and Effectiveness of the Policy
According to some, the time period between 2017 and 2040 is sufficient to be able to
implement the policy. (Chrisafis and Vaughan 2017) The implementation of policy may not
have to face may issues from the production side since it is believed that the market for
electric vehicles will be sufficiently well developed until the period of 2040. Currently,
several big car manufacturers are involved in manufacturing electric vehicles. (Chrisafis and
Vaughan 2017) In this situation, no investment in productive capacity may be required to
produce substitutes like electric vehicles. Given the process of subsidies and the presence of
many large automobile manufacturers in France, it is possible that the market mechanism
will ensure that France is ready for change until the implementation is complete.
Additionally, the reduction in demand for petrol and diesel will lead to lower prices of these
fuels. France has pledged to phase out fossil fuel subsidies and the reduction in consumption
will make it easier for France to fulfill this pledge. (Worall and Runkel 2017) Thus, the
policy is effective not only from the point of view of climate change but also from the point
of view of trade and current account balance.
4. Conclusion
The implementation of the policy does not seem to have plenty of problems from the point of
view of production and availability of substitutes. On the other hand, implementation of the
policy will accrue considerable social benefits and will also help France fulfill its
commitments to the Paris Climate Change Accord as well its commitment to phase out fossil
fuel subsidies.
Bibliography
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(accessed October 8, 2017).
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