The Use of Cars Causes Market Failure Essay Sample

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To achieve an efficient use of resources it would be better if governments intervened to affect both the production and the use of cars. Explain the meaning of the terms ‘market failure’ and ‘the efficient use of resources’ and analyse whether economic theory can be used to support this argument. [25]

Market failure exists when the operation of a market does not lead to economic efficiency. It is a situation where a free market does not produce the best use of scarce resources. Typical examples are when externalities are present, when there is monopoly power or where it is necessary for public and merit goods to be provided by the government or even when there is possible excessive profits or the need for very large investments. The strongest case for government intervention in the micro economy arises from market failure.

In order for resources to be efficiently used, it must be allocatively and productively efficient. Productive efficiency has to do with producing with the least possible scare resources. Allocative efficiency has to do with the production of the products that are most wanted. Efficient use of resources is termed as economic efficiency, and this is said to exist when it could be judged that all of our scare resources are being used in the “best” possible way. It represents the best possible solution to the economic problem. It is only realized when both allocative and productive efficiency co-exists. This is therefore known as optimum use of resources. Market failures have negative effects on the economy because an optimal allocation of resources is not attained. In other words, the social costs of producing the good or service (all of the opportunity costs of the input resources used in its creation) are not minimized, and this results in a waste of some resources.

Government can intervene through taxation, subsidies and regulation. Goods that produce negative externalities can be taxed to reduce its consumption and production. Producers may choose to bear the cost of the taxes or transfer the cost to the consumers. Also government can decide to intervene by promoting subsidies to producers of positive externalities. This would encourage them to produce more and also encourage others to also produce goods or services that promote positive externalities. Goods and services such as education, hospitals, medical care, etc. Government can also decide to create regulations to limit the quantity of output firms which create negative externalities can create. This is similar to a quota. One may ask how the use of cars causes market failure.

The use of cars causes negative externalities, due to the smoke it produces from its exhaust pipes. The “consumption” of cars produces several negative externalities. It is possible that negative externalities can arise from traffic congestion, from noise and from pollutants from car exhaust pipes. It could also arise from the road damage faced when cars ploy the roads. Also cars can cause market failure because the demand for them is unlimited but the supply is limited. This therefore presents the creation of a perfect equilibrium.

When people “consume” their cars, the social benefit would be less than the private benefit due to the negative externality of fumes from cars. Society however benefits because there is also positive externality from the consumption of cars. The purchase and use of cars would make public transport less crowded and more comfortable. Also government can benefit from the usage of the funds derived from the taxes imposed on the production of cars. Taxing the production of cars helps to solve the market failure its production creates. It might allow the production firms to finally achieve allocative efficiency.

In conclusion, the consumption of cars creates both positive and negative externalities. However the negative externalities it is more than its positive externalities so producers tend to overvalue and over produce. The government tries to intervene by imposing taxes on the production of cars. However this is not usually effective as the imposion of taxes depends on the elasticity of the product.The demand of cars is not price elastic.

In the diagram above, we have a normal downward sloping demand curve and two upward sloping supply curves. The lower one, the marginal private cost, represents the car firm’s supply curve (remember that the firm’s supply curve is also its marginal cost curve). The other one, the marginal social cost, represents the true supply curve (and, therefore, the true marginal cost of production) for society as a whole, allowing for the external cost of production. This external cost is represented by the vertical distance between the two supply curves (AB). The car firm does not care about the pollution. The owner is simply interested in maximizing profits. The equilibrium price for him is where demand equals his supply curve, at point B, so output will be Q1 with price at P1. Given that there is pollution, though, the optimal point for the whole of society is at C, where output is Q2 and price P2. Hence, if left to the free market, cars will be over-produced at a price, which, in terms of society, is too low. The triangle ABC represents the total deadweight loss to society as a result of the firm producing at point B. All the points within the area ABC are ones where the cost to society (represented by the MSC curve) is higher than the benefit to society (represented by the demand curve). It is a welfare loss, or a position of allocative

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