ECON 330 Week 3: Free Market vs. Environmental Quality and Natural Resource Management

Definition of market failure

Market failure refers to a situation in which the market system fails to allocate resources efficiently. This can occur for a variety of reasons, such as the presence of externalities, public goods, market power, or informational asymmetries. When market failure occurs, government intervention may be needed to correct the problem and promote economic efficiency. In other words, inefficiencies linked to technical externalities may lead to a form of market failure. A market failure may produce too much or too little of a good or service, leading to a suboptimal outcome for society as a whole.

Examples of Market Failure That Would Prevent an Efficient Outcome With Respect To Environmental Quality

A market failure with respect to environmental quality occurs when the market cannot distribute resources in a way that make the most of the welfare of society. One example of a market failure in this context is the tragedy of the commons. The tragedy of the commons occurs when a resource, such as a public park or a body of water, is shared by many individuals and no one has the incentive to conserve it because the cost of not doing so is not borne by the individual but by society as a whole (Helbling, 2020). This results in overuse and degradation of the resource.

Another example of a market failure is the problem of externalities. Externalities are the costs or benefits of an economic activity that are not reflected in the market price of a good or service. For example, a factory that pollutes a river may not have to pay for the cost of cleaning up the pollution, and as a result, the factory has an incentive to pollute more than is socially optimal. A third example of a market failure is the undervaluation of natural resources. Natural resources, such as forests or fisheries, are often not priced correctly in the market because they are not fully understood or their value is not fully realized. As a result, these resources may be overused and not properly managed. In all these cases, market failure can prevent an efficient outcome with respect to environmental quality. Government intervention, such as regulation, taxes or subsidies, may be necessary to correct for these market failures and ensure that resources are used efficiently and sustainably.

Kind of Government Policies That Economists Recommend to Correct Market Failure

Economists recommend several types of government policies to correct market failure caused by externalities. One policy is the imposition of taxes or fines on activities that generate negative externalities, such as pollution (Ehrenberg et al., 2021). This serves to increase the cost of the activity and discourage it. Another policy is the provision of subsidies to activities that generate positive externalities, such as education, to encourage more of the activity.

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Another policy is the creation of regulations and standards that limit the amount of pollution or other negative externalities that firms are allowed to produce. This can be done by setting emissions limits for factories or by requiring firms to use certain technologies that reduce pollution. Another policy is the creation of property rights for resources or activities that generate externalities (Angelis et al., 2019). For example, the government can give individuals or firms the right to emit a certain amount of pollution, and then allow those rights to be bought and sold on the market. This creates an economic incentive for firms to reduce their pollution and for firms that can reduce pollution at a low cost to sell their excess rights to firms that find it more expensive to do so.

Lastly, government can also invest in research and development of new technologies that can help reduce negative externalities and increase positive externalities. This can be done through grants or other forms of financial support for firms or researchers working on these technologies (Furton & Martin, 2019). Overall, economists recommend a combination of these policies, tailored to the specific market failure, in order to correct market failure caused by externalities. These policies can help ensure that the cost of externalities is reflected in the prices of goods and services, improving the efficiency of the market and protecting society from the negative impacts of externalities.

Reflection

The great lesson from the assignment is that market failure can occur when the market is not able to properly account for externalities. Also, I have learned that policies to mitigate market failure caused by externalities include regulation and taxation, as well as subsidies for positive externalities. For example, a carbon tax could be imposed on firms that emit pollutants in order to internalize the negative externality of pollution. In the workplace, I could apply this concept by considering the externalities of the production processes and implementing policies to reduce negative impact on third parties. In everyday life, I can consider the externalities of consumption choices and make an effort to reduce their negative impact on the environment.

ECON 330 Week 3: Free Market vs. Environmental Quality and Natural Resource Management References

De Angelis, E. M., Di Giacomo, M., & Vannoni, D. (2019). Climate change and economic growth: the role of environmental policy stringency. Sustainability, 11(8), 2273. https://www.mdpi.com/2071-1050/11/8/2273

Ehrenberg, R. G., Smith, R. S., & Hallock, K. F. (2021). Modern labor economics: Theory and public policy. Routledge.

Furton, G., & Martin, A. (2019). Beyond market failure and government failure. Public Choice, 178(1), 197-216. https://link.springer.com/article/10.1007/s11127-018-0623-4

Helbling, T. (2020). Externalities: prices do not capture all costs. Finance & Development. https://www.elibrary.imf.org/view/journals/022/2017/005/article-A018-en.xml

Please note that if you edit your initial response (original post), you will not get credit for the original post. The discussions are set up as “Must post first.”

Read the following article:

Externalities: Prices Do Not Capture All Costs
Markets will generally provide efficient solutions so long as there aren’t significant market failures. Market failure is defined at the end of Keohane and Olmstead, Chapter 4 (and in greater detail in Chapter 5 which is the assigned reading for next week). Answer all of the following questions in your initial response to the topic:
What is a market failure?
What would be an example of a market failure that would prevent an efficient outcome with respect to environmental quality?
What kind of government policies do economists recommend to correct market failure?
Reflection: Include a paragraph in the initial response in your own words using microeconomics terminology, reflecting specifically on what you learned from the assignment and how you think you could apply what you learned in the workplace or in everyday life.

Your answers should be written in your own words. Don’t use quotes from the articles.

You are expected to make your own contribution in a main topic as well as respond with value-added comments to at least two of your classmates as well as to your instructor.