Question

1. According to Cunningham (2011: 28-29), there are serious consequences for market failure by a nation, and particularly in a small and endowed country like Sierra Leone. Discuss 5 of those consequences that can arise due to market failure.                                                            
   
2. Discuss 5 recommendation as how the government of Sierra can overcome with market failure                                                                                                                     
   
3. Why is it often suggested that imperfect information will result in a misallocation of resources? How can such a misallocation be avoided?                                          
   
   
4. What is the another term of impact information as used in the Case of Sierra Leone?
                                                                                                                                     (1 mark)
5. Suppose in Sierra Leone, raising taxes or borrowing are your only two choices of financing current expenditures, which would you choose, and why, if you were in charge of setting policy?                                                                                                                   
   
6. We have learned from this course that the real value of the debt is eroded by inflation and may be overestimated because of it and other factors. Discuss whether you feel that the debt will be a major concern during your working lifetime and retirement why or why not?                             

Answer 1

1.

Market failure occurs when the price mechanism fails to account for all of the costs and benefits necessary to provide and consume a good. The market will fail by not supplying the socially optimal amount of the good.

Prior to market failure, the supply and demand within the market do not produce quantities of the goods where the price reflects the marginal benefit of consumption. The imbalance causes allocative inefficiency, which is the over- or under-consumption of the good.

The structure of market systems contributes to market failure. In the real world, it is not possible for markets to be perfect due to inefficient producers, externalities, environmental concerns, and lack of public goods. An externality is an effect on a third party which is caused by the production or consumption of a good or service.

During market failures the government usually responds to varying degrees. Possible government responses include:

• legislation – enacting specific laws. For example, banning smoking in restaurants, or making high school attendance mandatory.
• direct provision of merit and public goods – governments control the supply of goods that have positive externalities. For example, by supplying high amounts of education, parks, or libraries.
• taxation – placing taxes on certain goods to discourage use and internalize external costs. For example, placing a ‘sin-tax’ on tobacco products, and subsequently increasing the cost of tobacco consumption.
• subsidies – reducing the price of a good based on the public benefit that is gained. For example, lowering college tuition because society benefits from more educated workers. Subsidies are most appropriate to encourage behavior that has positive externalities.
• tradable permits – permits that allow firms to produce a certain amount of something, commonly pollution. Firms can trade permits with other firms to increase or decrease what they can produce. This is the basis behind cap-and-trade, an attempt to reduce of pollution.
• extension of property rights – creates privatization for certain non-private goods like lakes, rivers, and beaches to create a market for pollution. Then, individuals get fined for polluting certain areas.
• advertising – encourages or discourages consumption.
• international cooperation among governments – governments work together on issues that affect the future of the environment.

2).

Market failure occurs due to inefficiency in the allocation of goods and services. A price mechanism fails to account for all of the costs and benefits involved when providing or consuming a specific good. When this happens, the market will not produce the supply of the good that is socially optimal – it will be over or under produced.

In order to fully understand market failure, it is important to recognize the reasons why a market can fail. Due to the structure of markets, it is impossible for them to be perfect. As a result, most markets are not successful and require forms of intervention.

Reasons for market failure include:

• Positive and negative externalities: an externality is an effect on a third party that is caused by the consumption or production of a good or service. A positive externality is a positive spillover that results from the consumption or production of a good or service. For example, although public education may only directly affect students and schools, an educated population may provide positive effects on society as a whole. A negative externality is a negative spillover effect on third parties. For example, secondhand smoke may negatively impact the health of people, even if they do not directly engage in smoking.
• Environmental concerns: effects on the environment as important considerations as well as sustainable development.
• Lack of public goods: public goods are goods where the total cost of production does not increase with the number of consumers. As an example of a public good, a lighthouse has a fixed cost of production that is the same, whether one ship or one hundred ships use its light. Public goods can be underproduced; there is little incentive, from a private standpoint, to provide a lighthouse because one can wait for someone else to provide it, and then use its light without incurring a cost. This problem – someone benefiting from resources or goods and services without paying for the cost of the benefit – is known as the free rider problem.
• Underproduction of merit goods: a merit good is a private good that society believes is under consumed, often with positive externalities. For example, education, healthcare, and sports centers are considered merit goods.
• Overprovision of demerit goods: a demerit good is a private good that society believes is over consumed, often with negative externalities. For example, cigarettes, alcohol, and prostitution are considered demerit goods.
• Abuse of monopoly power: imperfect markets restrict output in an attempt to maximize profit.

When a market fails, the government usually intervenes depending on the reason for the failure.