Other Interventions to Address Market Failure (DP IB Economics)

Revision Note

Written by: Steve Vorster, Economics & Business Subject Lead

Reviewed by: Jenna Quinn, Head of New Subjects

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

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
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
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 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

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

Last updated: 19 March 2024

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