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Market Failures and Externalities: Addressing Imperfections in Capitalism

Explore the concept of market failures and externalities in capitalism and the need for intervention to address these imperfections. Learn about different types of externalities and strategies to internalize the costs.

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Market Failures and Externalities: Addressing Imperfections in Capitalism

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  1. Session 1 When the market is helpless: market failures and externalities

  2. Capitalism and the market • Capitalism is based on the assumption that resources are best allocated through the market. • A market is efficient if the resources are neither over-allocated (too much of the good) nor under-allocated (too little of the good) • Market efficiency derives from perfect competition and perfect information: free market • Liberalism and laissez-faire: state intervention should be minimal • Removing the obstacles to free market • Is the market always perfect?

  3. Imperfect markets • Most economists agree that the market is not always perfect. When does this happen? • Imperfect competition • Monopolies and cartels • Barriers to trade • Externalities • Public goods - often related to externalities • Equity / Ethical principles • Instability: recession or bubbles • These imperfections are called market failures, and often justify state’s intervention

  4. How can market failures be solved? • Two possible avenues: • Social democrats argue for an intervention of the state in the economy • Neoliberals promote market-based solutions • Different types of policies: • Regulations • Subsidies and taxes • Public provision of a good • ...

  5. Externalities • An externality occurs when a party external to a market unvoluntarily bears the costs or receives benefits related to a transaction of the market. • Definition not easy: tendency to focus on what they do instead of what they are. • Meade: An external economy (diseconomy) is an event which confers an appreciable benefit (inflicts an appreciable damage ) on some person or persons who were not fully consenting parties in reaching the decision or decisions which led directly or indirectly to the event in question.

  6. Different types of externalities • Positive and negative externalities: • Smoking • Gardening • Public (undepletable) and private (depletable) externalities • Air pollution • Wireless internet networks • Technological (real) and pecuniary (fake) externalities • Oil spills • Price of oil

  7. Internalising the costs

  8. How to meet the social costs • Command and control • Laws and regulations • Civil tort law • Class actions • Concept of ecological damage • Provision by the government • Public goods • NGOs and charities • Pigouvian taxes and subsidies • Aim to correct a bad - often the most favoured option

  9. Relation to public goods • Public goods are best understood as one particular type of externalities • The internationalisation of externalities compromises the provision of public goods

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