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IBEconomicsDPHLRevision Notes2. Microeconomics2.8 Market Failure: Externalities & Common Pool (Access) ResourcesOther Interventions to Address Market Failure

Other Interventions to Address Market Failure (DP IB Economics)

Revision Note

Steve Vorster

Written by: Steve Vorster

Reviewed by: Jenna Quinn

DP Economics: HLDP Economics: SL

Tradable Pollution Permits

  • Governments calculate an optimum (or preferable) level of pollution

  • They then create a pollution permit market and issue permits to polluting firms

    • This is also known as a Cap and Trade Scheme (CATs)

    • Each permit is typically valid for the emission of one ton of pollutant

    • Firms that pollute more have to buy additional permits from less-polluting firms

    • The price of the permit represents an additional cost of production which reduces the supply

    • This helps to reduce negative externalities of production

    • The price of the permit changes as it is determined by demand and supply
        

  • If the cost of additional permits is more than the cost of investing in new pollution abatement technology, firms will be incentivised to switch to cleaner technology

    • Firms can then sell their spare permits and gain additional revenue
       

Evaluating the use of Tradable Permits


Evaluation Point


Explanation

Challenges involved in the  measurement of externalities

  • Is extremely difficult to calculate the level of CO2 emissions in an economy and this level constantly changes

  • The initial number of permits is based on this calculation and should ideally be significantly less

  • If the calculation is too high then the permits will have no impact on emissions whatsoever

Degree of effectiveness

  • It still provides a permit to pollute

  • When the calculations are correct, it can be effective in decreasing emissions and reducing the welfare loss

  • Larger firms have the resources to buy all the permits while smaller firms struggle. Over time this can effectively create monopolies in polluting industries

  • If the demand for the end product is price inelastic in demand, then firms will pass on the cost of this permit to their consumers in the form of higher prices

Consequences for stakeholders

  • Increased costs of production for firms

  • Some firms may invest in new technology so that the permits are not required

  • Some firms may no longer be able to compete

  • Some firms may switch their production to countries with no pollution permit scheme

  • Higher prices for consumers

International Agreements

  • International Agreements aim to address the negative externalities of production and consumption that are global in nature. These agreements typically focus on: 

  1. Common pool resources such as international fishing waters e.g. the North East Atlantic Fisheries Commission (NEAFC) is representative of member countries and sets annual limits on fishing in the North East Atlantic

  2. Environmental and climate change challenges e.g. Cop 27 ( the United Nations Framework Convention on Climate Change) has 165 countries working together to reduce global warming

  3. Global trade in demerit goods e.g. the United Nations Office on Drugs and Crime has 27 countries working together to combat organised crime
     

Evaluating the use of International Agreements


Advantages


Disadvantages

  • Many problems require a globally co-ordinated response and the reduction in welfare loss is greater when countries work together

  • Resources can be pooled and used for the greatest good

  • Levels of international cooperation and interdependence can increase

  • More economically developed countries (MEDCs) have developed using 'dirty technologies'. Less economically developed countries (LEDCs) are under pressure to accept agreements which reduce the use of 'dirty technology' and this may not be realistic as it would decrease their economic growth

  • There are usually no legal consequences to withdrawing from international agreements

  • When new political parties come to power they may seek to change agreements or withdraw from them e.g. President Trump withdrew USA support for the Paris Climate Change agreement

Collective Self-governance

  • Collective self-governance occurs when the stakeholders in a community work together to combat the negative externalities of production usually associated with common pool resources

Evaluating the use of Collective Self-governance


Advantages


Disadvantages

  • Working together can provide a common purpose and build a community

  • The community knows how to best manage scarce resources in a sustainable way and it is in their best interests to do so

  • Communities can create employment opportunities related to managing the scarce resources

  • A powerful strategy that has been beneficial to promoting eco (sustainable) tourism in many areas e.g. Borneo rain forests

  • The welfare loss is reduced

  • There can be disagreement about how to best manage the resources

  • Taking back control of common pool resources from multinational corporations or organised crime gangs can be highly confrontational/violent

  • This strategy works better when private property ownership rights are given to the communities for the natural resources around them

Government Provision

  • Merit goods and public goods are under-provided thus causing market failure
     

  • Public goods are beneficial for society and are not provided by private firms due to the free rider problem

    • They are usually provided free at the point of consumption but are paid for through general taxation

    • Examples include roads, parks, lighthouses, national defence
       

  • Merit goods are beneficial to society but consumers cannot always access them as they are priced out of the market (e.g. private education or healthcare)
     

  • One of the final ways to address the under-provision of goods and services is for governments to provide them
      

Evaluating the use of Government Provision


Advantages


Disadvantages

  • Essential /valuable goods and services are usually provided free at the point of consumption

  • They are accessible to everyone regardless of income

  • These usually provide both private and external benefits to society

  • Paid for through general taxation

  • There is an opportunity cost associated with their provision

  • Products which are free may result in excess demand and long waiting times e.g. procedures at Public hospitals

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    Author
    Reviewer
    Steve Vorster

    Author: Steve Vorster

    Expertise: Economics & Business Subject Lead

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.

    Jenna Quinn

    Author: Jenna Quinn

    Expertise: Head of New Subjects

    Jenna studied at Cardiff University before training to become a science teacher at the University of Bath specialising in Biology (although she loves teaching all three sciences at GCSE level!). Teaching is her passion, and with 10 years experience teaching across a wide range of specifications – from GCSE and A Level Biology in the UK to IGCSE and IB Biology internationally – she knows what is required to pass those Biology exams.