Question

please outline in three more paragraphs total, your understanding of the following concepts:

*Free rider problem;

*What causes market failure and why from your point of view;

*Outline your understanding of spillover costs and spillover benefits and use at least two examples.

*Outline your understanding of private market failure versus public market failure and give an example for each.

Answer 1

Free Rider Problem - The Free Rider Problem arises when people gets benefited from resources, goods and services but they do not pay for it. When there are free-riders in an economy, some people would be forced to pay more and get the same benefit of getting a particular good that the free-riders are also getting. This leads to market failure because then, even the people are still paying for the good would get the incentive of not paying for it when they see other people consuming the same good for free. This in-turn would lead the resources or the good to be under provided in the economy. Free Rider Problem mainly arises with the public goods in a country which are neither excludable nor rival in consumption.

The causes of Market Failure are:

(1) The Free Rider Problem - As stated above, when many people are taking advantage of a good or a service without paying for it, it would cause the good or the service to be under provided in the economy. This leads to Market Failure because here the market cannot operate. For example, in the case of National Defense, even if some people do not pay the tax they would still enjoy the peace he gets at home because our soldiers are protecting our country all the time. Now, the government has to pay the army every month and also buy defense equipment. If more and more people does not pay the tax, then the government will not have enough resources to pay the army and the country's defense power would weaken.

(2) Property Rights - When there are no proper property rights in the market, the market fails to allocate the resources efficiently. Property Rights problem mainly arises in the case of common resources. Common resources are those goods which anyone can use it for free of cost. Examples of common resources are air, water etc. Air is available everywhere around us, we all survive because of the air. For example, a farmer benefits from a river he has beside his farm i.e. he can use the water from the farm for cultivation. Now, he also uses pesticides, but some of this pesticide leaks to the nearby river and the fishes in the rivers are affected. This leads to the fishermen getting affected because half of the fish they catch are either dead or not fit for consumption. Hence, this whole process leads to the problem of market failure.

Spillover cost and Spillover benefits - Spillover cost arises when an individual or a firm does not bear the cost of his production or things he is doing but passes it to the society. Spillover benefits arises when an action of an individual or a firm benefits the society as a whole. Spillover cost leads to negative externality and Spillover benefits leads to positive externality.

Example of Spillover Cost - When a person say Sam is paying loud music in his home but he has a neighbour staying just beside his home who is extremely sick and bedridden. Sam gets the benefit of paying the loud music but his neighbour incurs the spillover cost and he can't sleep and his condition worsen.

Example of Spillover benefit - A firm innovates a new medicine which can cure a disease for which there was no cure available before. This benefits the society as a whole and also other firms in the same industry gets an idea of making similar medicines to cure the disease.

Private Market failure vs public market failure - Private market failure arises when market failure arises from the resources that are owned privately and public market failure arises from the resources owned by the public.

Example of Private Market failure - In the example above, Sam is paying loud music in his own house, in his own music player. His neighbour on the other hand, is also staying in his own house but getting discomfort from the loud music. This is thus a private market failure example.

Example of Public Market failure - In the first example, National defense is a public market failure since the government pays for the defense of a country but the free rider problem of the nation's individuals exists.