MARKET FAILURES

Market Failures

Market Failures

Market power and externalities are examples of a general phenomenon called market failure, the inability of some unregulated markets to allocate resources efficiently. When market fails, public policy can potentially remedy the problem and increase economic efficiency. Individual consumers will often purchase goods with an environmental component to make up for their inability to, directly purchase environmental goods, thus revealing the value they hold for unquestionable aspects of environmental quality. For example, someone may buy a cabin on a lake in order to enjoy not only the home itself but also the pristine environment that comes with such a purchase. As long as this individual, exclusively incur the environmental benefits that come from owning a log cabin, the demand for log cabins will reflect the full value of both the home and the environmental goods it provides and the market for log cabins will be efficient.

Unfortunately, in the case of environmental goods, markets often fail to produce an efficient result because it is rare that any one individual can incur the full benefit (or cost) of a level of environmental quality. This is because environmental goods commonly suffer from the presence of externalities or a lack of property rights. There are two types of externalities: negative and positive. Negative externalities exist when individuals in society bear a portion of the cost associated with the production of a good without having any influence over the associated production decisions (Baumol & Oates, 1988). For example, parents may be required to pay higher health care costs related to pollution-induced asthma among children because of an increase in industrial activity, in their neighborhood.

Because producers do not consider these costs in their production decisions, they produce higher quantities of goods with negative externalities than is efficient, leading to more than the socially desirable level of environmental degradation. As with negative externalities, positive externalities also result in inefficient market outcomes. However, goods that suffer from positive externalities provide more value to individuals in society than is taken into account by those providing these goods. An example of a positive externality can be seen in the case of college roommates sharing an off-campus apartment.

Though a clean kitchen may be valued by all individuals living in the apartment, the person that decides to, finally wash the dishes and scrub the kitchen floor is not fully compensated for providing value not only to him or herself ...