Market Failure - Public Goods, Private Goods and Imperfect Market Knowledge

Give an example of asymmetric information when the consumer knows more than the seller

A consumer may purchase an insurance policy concealing information about himself or simply know more about intended future actions. This might a risky lifestyle.

What is a Public good?

A product that is not produced at all through the markets, offering significant benefits to society. Where public goods occur is known as the 'missing market'. These goods involve a large element of collective consumption; such as national defence, flood defence systems and the criminal justice system. Public goods demonstrate characteristics of non-excludability and non-rivalry.

Give an example of asymmetric information when the seller knows more than the consumer

A second-hand car salesman, for example, may have greater knowledge of the history of vehicles for sale as well as more technical knowledge than consumers. This could lead to a consumer paying too much for a poor-quality car. The fear of buying a defective car tends to reduce the market price for all second-hand cars, including the non-defective ones. Consequently, both buyers and sellers can suffer from this. This is known as the lemon market.

Explain the Government provision of public goods

In a mixed economy the government tend to provide public goods in order to correct market failure. It raises funds from general taxation to pay for their provision. Without government intervention, public goods may be under-provided or not provided at all. The actual quantity provided will be less than the amount required for achieving the social optimum position.

What is the valuation problem?

It is difficult to measure the value obtained by consumers of public goods and hence it becomes hard to establish a market price for them. It is in the interests of consumers to under-value the benefit gained from a public good so that they pay less for it; but it is in the interests of producers to over-value the benefit gained from a public good in order to charge more for it. The uncertainty over valuation may deter firms from providing public goods.

What is the free-rider problem?

Once a public good has been provided for one individual, it is automatically provided for all. The market fails because it is not possible for firms to withhold the good from those consumers who refuse to pay for it.

What is an advantage of a public good?

Once a public good has been provided, the cost of supplying it to an extra consumer is zero. Further examples are firework displays, lighthouses, public beaches, public parks and street lighting.

What is a Private good?

Private goods are the opposite of public goods. They display characteristics of rivalry and excludability in consumption. An example of private good is a chocolate bar, the consumption of which directly excludes other people from consuming that particular bar. The owners of private goods are able to use private property rights which prevent other people from consuming them. Private goods, unlike Public goods, can also be rejected, which means one has a choice over whether to consume them or not.

Explain the Under-provision of public goods

Public goods are under-provided due to two problems known as the free rider problem and the valuation problem.

What is Asymmetric information?

This is when consumers and producers have imperfect and unequal market knowledge upon which to make their economic decisions and this could leas to a misallocation of resources.

What is non-rivalry?

This means that as more people consume a good and enjoy its benefits, it does not reduce the amount available for others. In effect, it is non-diminishable.

What is Non-exludability?

This means that once a good has been produced for the benefit of one person, it is impossible to stop others from benefiting.

What does Imperfect market information mean for the markets?

When there is imperfect market information, markets are likely to fail. This can be seen in the under-consumption of healthcare, education and pensions (sometimes known as merit goods) or the over-consumption of tobacco, alcohol and gambling (sometimes known as demerit goods).

What is Symmetric information?

Where consumers and producers have perfect and equal market information on a good or service. Assuming that consumers and producers act in a rational way, it will lead to an efficient allocation of resources.