Market Failure Essay

Introduction A key cause of climate change is the failure of the market system to efficiently allocate resources to deal with extensive negative externalities, specifically those caused by carbon – based gases polluting the atmosphere. Failure in the market system is having a extravagant impact on atmosphere. The allocation of resources is affecting the environment but more specifically the carbon based gases are polluting the atmosphere. This is resulting in global climate change. Potential solutions will be analysed throughout this essay to prevent market failure.

The solutions that will be considered are environmental taxation, government regulation and trading in marketable permits e. g. carbon credit market. Market Failure Economists recognise two main types of market failure – spillovers and public goods (Jackson, McIver, Bajada 2007: 208). These types of market failure are externalities and in some cases result in over allocation of resources. Spillovers occur when some of the benefits or costs associated with the production or consumption of a good ‘spill over’ to third parties; that is, to parties other than the immediate buyer or seller (Jackson, Mciver, Bajada 2007:204).

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Externalities are actions of one economic agent that have an impact on other economic agents, in either a negative or positive manner (Magill’s Choice 1999:569). Spillovers can occur under various categories for example the environment. The other type of market failure is public goods. Public goods are goods and services not provided by the market system, as they are indivisible and often not bound by the exclusion principle (Jackson, Mciver, Bajada 2007:206). Indivisible goods are goods that cannot be divided. The exclusion principle is simply consumers that don’t buy the product are excluded from the benefits.

This is related to market failure as public goods are not provided by the market and some cases aren’t able to be purchased. For example, infrastructure provided by the government, it’s a good but consumers can’t purchase it but they utilise it. Spillover costs are associated with the third parties when there is no compensation. Spillover costs are closely related to climate change as there are costs associated with repairing damage enforced on the environment which affects the third party. Air pollution is one aspect of climate change that affects third parties.

The pollution of resources in the atmosphere has been an ongoing issue for many years. Resources such as coal, oil and natural gas has released large quantities of carbon previously locked in underground rock layers and has increased the atmospheric concentration of carbon dioxide by a third (34%) since 1750 (Economist 1990). This is an example of a spillover cost where the third parties aren’t compensated for. Resources have been polluting the atmosphere for years but the third parties are unaware of it. Carbon based gases are polluting the atmosphere resulting in climate change.

The global warming caused by this greater concentration of carbon in the air is producing an anticipated speed of climate change greater than anything seen for at least 10,000 years (Economist 1990). Spillover costs regarding air pollution effect the third party as everyone requires oxygen to live, as the allocation of resources around the world continues, third parties are affected by the spillover costs. When production or consumption of a commodity inflicts costs on some third party without compensation, these are termed spillover costs. An example of a spillover cost is environmental pollution.

When a chemical manufacturer dumps wastes into a lake or river, swimmers, people who fish and sail, and whole communities that want a decent water supply suffer spillover costs. This diagram is an example of market failure, as it demonstrates how spillover coasts affect the allocation of resources. There is an over allocation of resources as more is supplied then what is demanded and the product is allocated. Qe the equilibrium output exceeds Qo the optimum output. The spillover cost is shown as T, which is where the externality of allocating the resource is displayed.

Market failure is portrayed through this diagram as the optimum output is higher then the equilibrium resulting with spillover costs. Property rights enable the parties to place a price tag on externality through negotiation, creating opportunities for both sides. The owner of property rights can negotiate with the party causing the negative externality. The owner will seek compensation for the cost of the externality (Jackson, Mciver, Bajada 2007:209). This is another issue regarding over allocating resources, as property is a commonly held resource. The externalities involved with property rights can be good for both sides.

Depending on the negotiation the owner can cause negative externality because they have property rights and can decide what to do with the property. The party involved will seek compensation for the externality but this can lead to a reduction in output. So properties are another resource where market failure can occur. Environmental taxation Environmental taxation is when the government taxes items that are effecting the environment to cover the externality cost. The government taxes mostly on carbon based emissions as they are a major contributor to the climate change.

Automobiles are a major contribution to effecting the environment. As shown below cars are the highest percentage on impacting the climate. Producers and consumers of automobiles are not required to compensate those affected by the air pollution of the factory, and as a result, they face artificially low prices and produce and consume too many cars (Magill’s Choice 1999:569). This results in the private car market failing as the quantity of cars is too high and if the costs associated with air pollution were included, it would be too much.

Due to this private market failing it is now the government’s job to tax automobiles to reflect the real costs involved. This then covers the costs arising from the health risks posed by pollution. Environmental taxes come in many different forms, but as a general matter environmental tax measures either impose a tax cost on some product or activity that is environmentally damaging, or they give a tax benefit to some product or activity that is environmentally beneficial (Macquarie University 2003). This is used in relation to carbon emissions in the atmosphere.

It is used in the private car market as there is a tax imposed to cover the environmental damage it creates. The world carbon dioxide emissions (measured tons) are 3. 9 per capita (Jackson, Mciver, Bajada 2007:211). If the environmental taxes were implied it wouldn’t lower the worlds carbon based emissions but it would help prevent market failure. It will potentially be a solution to market failure as there will be no spillover costs. Using the automobile as an example the government will pay for the environmental related taxes or externalities then the private seller will have optimal output as well as equilibrium.

Too many economists analysts, situations involving serious externalities taxes are the most effective mechanism for “getting the prices right” (Lawrence Goulder 1995:157-183). According to this “getting the prices right” theory it is verifying that taxes are effective in order to prevent market failure. Serious externalities such as climate change, taxes can be the most effective way for getting the market back to normal. Although dealing with automobiles there isn’t a way to reduce the carbon emissions there is energy efficiency solutions to other carbon gases contributors.

Efficiency within house hold appliances can be controlled to reduce the greenhouse gases. It’s as simple as changing a light bulb. Just one bulb can stop up to 100kg of greenhouse gas getting into the atmosphere each year (Dave Reay 2005:59) Environmental taxes are an effective way to reduce market failure under the category of carbon based gases. The government taxes exclude the externalities in a business that has spillovers regarding the environment. To reduce the air pollution however parties can use energy efficiency around there home to bring the overall carbon dioxide emissions down.

Government Regulation Government regulation is the control over entry and exit, prices, and financing with an industry (Magill’s Choice 1999:526). Regulation occurs when the government is convinced that a market failure will occur and they control the legal aspect about the business and state the consequences at hand. Regulation occurs in all types of business genres, from retail through to transport. The government can control the entry and exit of a business depending if they get the consent from the government to undergo a project.

An example occurred in china where firms where applying for credits to build gas-fire power plants instead of ones that run on coal. The firms were arguing it would improve the air quality (Economist 1990). The government was hesitating on regulating this concept though because of losing valuable credits. Government regulation is a big factor regarding environmental projects as firms need the government’s approval. This can assist in reducing market failure as the firms have environmentally friendly products that don’t cause externalities.

If the government approves of the business that it doesn’t cause environmental damage then there will be no spillovers, excluding market failure. Waste disposal techniques in some parts of the world are regulated to limit the waste ending up around the world. According to the European Union, e-waste is now the fastest-growing category. Last month new rules came into force in both Europe and California to oblige the industry to take responsibility for it (Economist 1990). Now in some parts of the world the government is putting the responsibility on the companies to control the waste disposal.

The companies listened to the government and are now implementing recycling systems for the company to adhere to. The graph below illustrates the annual greenhouse gas emissions referring to the global figures. Household produces the most gas emissions then followed by waste and transport. This is in relation to the government regulation because if they want to impede the pollution of the atmosphere then by focusing on the highest greenhouse gas emission and regulating that will assist in cleaning up the atmosphere.

Government regulation is another effective solution to preventing market failure. By focusing on the major carbon gas emissions and pursuing the categories they come under, will enable the government to regulate those topics. Also by limiting the damages businesses have on the environment will leave little to no externalities as third parties will not get involved. This will then minimise market failure as there will be no spillovers. Finally by the government enforcing laws about recycling, waste disposal etc the climate will benefit from it. Trading in marketable permits

A marketable permit is a permit issued by the government which then can be bought or sold and it allows a business to discharge a certain amount of pollution. This is used in controlling the pollution escaping into the world as the companies are only allowed to dispense a certain amount. One market is the carbon credit market that specially operates with greenhouse gases. This market deals with capping greenhouse emissions and allocating them to other useful resources. This approach is used to lower the emissions and limit the amount of carbon dioxide entering the atmosphere.

The demand for carbon credits comes mostly from within the ETS, from polluters who need certificates allowing them to emit carbon. There is some demand from Japan, which has a voluntary scheme, and from companies and individuals elsewhere in the world who want to offset their emissions for moral reasons, or to make themselves look good (Economist 1990). So in other words the consumers buying the carbon credits want to make their business look good so there are no externalities coming from third parties because they have proof that they are not polluting. This is an example of a carbon credit market that trades carbon – based gases.

The company is called Chicago Climate Exchange and it is one of the few companies in the world that caps and trades greenhouse emissions. This graph shows the prices and volume of greenhouse gases traded. This company is effectively allocating resources to prevent market failure. They are preventing the carbon-based emissions entering the atmosphere and instead, cap and trading them. This will assist in preventing market failure for other businesses as it will enable other business to sell there greenhouse gases to companies like this and vice versa, minimising the externalities within the business.

Most Efficient Approach After analyzing the solutions only two solutions would be appropriate in Australia that is the Environmental taxation and Government regulation. The environmental taxation would be efficient because there will be less market failures and less people polluting. The government regulation on the other hand will reduce the pollution to the atmosphere and also contribute to the reduction of market failure. The most efficient approach is the trading in marketable permits. This solution was assigned because it is an efficient way to allocate resources and deal with negative externalities.

The externalities are limited because it is taking the externalities which are the pollutants and efficiently allocating them. This will then prevent climate change as the market system is efficiently allocating the resources. This solution however is only being used in certain parts of the world but it should be introduced all over the globe. Conclusion This essay has many conclusions about preventing market failure to better the environment. The solutions all revolve around eliminating externalities which therefore eliminates market failure. But to eliminate externalities there has to be minimal pollutants to the atmosphere.

All the solutions will work but the trading in marketable permits is the more efficient solution. Ashiabor, H. 2003, critical issues in international environmental taxation – international and comparative perspectives, viewed 12 May 2009 http://www. law. mq. edu. au/eti/ Goulder, LH 2004, Environmental taxation and the double dividend: A readers guide, international tax and public finance, Vol. 2, NO. 2, Springer Netherlands, Date accessed: 12 May 2009 J, Jackson, R, McIver, C, Bajada, 2007, Economic Principles 2nd edition, McGraw – Hill,

North Ryde, Australia Economist 2008, ‘A moment of truth’, 17 May, p 74-75, viewed 12 May 2009, Ebscohost Economist 2006, ‘How green is your apple? ’, 26 August, p 49, viewed 12 May 2009, Ebscohost Economist 2007, ‘Trading thin air’, 2 June, p 8-12, viewed 12 May 2009, Ebscohost Reay, D 2006, Climate change begins at home, Macmillan, New York 1991, Economics Basics, Magill’s Choice, Vol 2, pp. 526-569. 2003, CCX carbon financial instrument – Chicago climate exchange, viewed 12 May 2009 http://www. chicagoclimatex. com/market/data/summary. jsf


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