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© Tutor2u Limited All Rights Reserved. These study notes are protected by copyright and may not be reproduced in part or in whole, for whatever reason, without the prior written permission of tutor2u. The use of tutor2u content for commercial gain of any kind is strictly forbidden. We reserve the right to take legal action against any party or parties found to have breached our copyright. AS Market FailurePositive Externalities |
There are many occasions when the production and/or consumption of a good or a service creates external benefits which boost social welfare. In this note we consider the idea of positive externalities and the market failure that can result if the market under-consumes or under-provides these sorts of products. Examples of positive externalities
Positive externalities and market failure
Where positive externalities exist, the good or service may be under consumed or under provided since the free market may fail to value them correctly or take them into account when pricing the product. In the diagram above, the normal market equilibrium is at P1 and Q1 – but if there are external benefits, the Q1 is an output below the level that maximises social welfare. There is a case for some form of government intervention in the market designed to increase consumption towards output level Q2 so as to increase economic welfare.
Bird flu vaccine being prepared The economics of vaccination What good is a vaccination? Obviously there are benefits for the person receiving the vaccine, they are less susceptible to disease and children in particular are more likely to attend school and earn more income over their lifetime. A new study on the economic effects of vaccinations from the World Bank finds that well designed and comprehensive vaccination programmes have a positive effect on savings and wealth and encourage families to have fewer children which lead to less demographic pressures on scarce resources. More subtly, it can be good for an entire population since, if enough of its members are vaccinated, even those who are not will receive a measure of protection. That is because, with only a few susceptible individuals, the transmission of the infection cannot be maintained and the disease spread. In the case of many vaccines, there are non-medical benefits, too, in the form of costs avoided and the generation of income that would otherwise have been lost. These goods are economic. The dispassionate economic case for vaccination, therefore, looks at least as strong as the compassionate medical one. Spending on vaccination programmes appears to be a sound social investment for the future. Source: Adapted from the Economist, October 2005 Vocational training – externalities and market failure There is growing evidence that skilled workforces have positive impacts on high-level economic aims, such as raising productivity and enhancing a country's GDP growth. At the same time, there is evidence of a major skills deficiency in the UK, which is reflected in the low numbers of people holding intermediate level vocational qualifications, compared to Germany and other European Union countries. There is further evidence that there are three forms of market failure that continue to cause this skills gap: 1. Externalities leading to under-investment in training by employers. Firms are concerned that once trained, an employee will leave the firm before the firm has recouped its investment. Unless training pays off very quickly, firms are therefore reluctant to provide training to their workers. This is an example of the free-rider problem - where one firm can take advantage of the money invested in training by another firm. Fewer than four in ten employers in the UK provide some off-the-job training each year. 2. Imperfect information leading to employees (workers) being unable to judge the quality of their training or appreciate the benefits to themselves. This reduces their willingness for example to accept lower wages during the training period or to receive any training at all. 3. Credit market imperfections. Training is a costly business, but individuals expect to obtain higher wages from training in the long-term (i.e. their wages are likely to be higher in jobs that require a greater degree of training and specific skills). Some individuals may wish to borrow money to fund training in the expectation that they will be able to pay back the loan through higher future wages. However, low-paid employees in particular are likely to be "credit constrained" and unable to obtain loans to pay for training. These market failures mean that the level of training provided by the market is likely to be inefficiently low from society’s point of view. Well-designed government intervention may help to bridge the gap How can government intervention help to resolve the “training gap?” The aims of government intervention might be to
Options for government intervention
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| Author: Geoff Riley, Eton College, September 2006 |
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