Reading Notes:Market Failures

Herman E. Daly and Joshua Farley


Mo’ markets, mo’ problems.

Under the right conditions, free markets are a fantastic way to distribute goods. Under other conditions they are not. This chapter discusses what those conditions are, and alternative systems that might be good to implement.

Types of Goods

It’s important to think about the excludability and rivalness of goods and services being distributed.

Excludable goods can be clearly owned by a person or group. (ie access to food, but not access to a sunset.) 

Rival goods are less useful to one person when a second person uses them. (ie if I eat some food you can’t, but if I enjoy a sunset you still can.)

Markets work best with excludable, rival goods. They destroy nonexcludable rival goods (like  open-access fisheries) and tend to overprice excludable nonrival goods (like AIDs drugs in developing countries.) Nonexcludable, nonrival goods (like national defense or NPR) are best to manage with nonmarket mechanisms. 

There are also congestible goods, which are nonrival at low use and rival at high use. These are best managed with congestion pricing.

Public Goods are both nonrival and nonexcludable. The money to create them has to be raisedsomehow, but markets can’t do it. This creates a “free rider” problem- it’s more benicial for people to not chip in and get the benefit than to chip in and get just a little more benefit.

Externalities– are what happens when an action creates an uncompensated loss or benefit elsewhere. Some say that the answer is to use market mechanisms to internalize the cost. Coase theorem talks about how to do this, and argues that in an economically perfect world it doesn’t matter who’s paying- the polluters paying to pollute or the pollutees paying to not be dumped on. They will eventually negotiate a socially optimal outcome. There are a couple of nasty assumptions here though, such as:

Wealth affects– this assumes that both groups have enough money to have an even playing field. Who has to pay impacts wealth disparity, which has other economic implications.

Transaction costs– when externalities are felt by large populations (which they generally are) collective bargaining becomes extremely costly and the economics break down.

Missing Intergenerational Market-Externalities which are felt only by future generations cannot be reflected in today’s markets, transaction costs are effectively infinity. Nonmarket mechanisms are required to manage these externalities.


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