Readers Question: Have you seen question 16 on AQA’s objective test (multiple choice) paper from last January? – link below. I can’t see the logic in the correct answer being B, as per the mark scheme. Any idea?
16 Which one of the following is associated with a missing market?
A. A monopoly restricting output
B. The production of a negative externality
A missing market is a type of market failure. A missing market means that there is some obstruction to an efficient free market which would enable a Pareto efficient distribution of resources but for various reasons this market doesn’t exist. This obstruction could involve poor information, high transaction costs or the inability to price all social costs / benefits e.g. through externalities.
Example of Missing Market – Negative Externality
- Suppose a firm produces chemicals but pollutes a river as a by product.
- When producing the good, the firm ignores the external cost. This will cause a cost to fisherman who will lose revenue from the fact fish are dying.
- If the fishermen had property rights they could sue the chemical firm for the external costs they create. This would mean the external costs would be included in the price of the chemicals. This would enable a Pareto efficient outcome – either the firm would not pollute or they would give fishermen compensation for their lost revenue.
- The negative externality causes overconsumption.
- Negative Externalities
Training workers may create a positive externality. This can lead to under provision of training because firms will not want to undertake training if they may not benefit but worker leaves and works elsewhere. If firms could be rewarded for the positive externalities they create it would lead to a socially efficient outcome.
Moral Hazard could lead to a type of missing markets. Firms don’t want to insure goods because the insurance encourages reckless behaviour.
I find the terminology of ‘missing markets’ somewhat obscure. I wouldn’t teach externalities as a missing market, but just market failure. With externalities it feels more accurate to talk about a partial market which fails to account social costs and social benefits.
In the case of public goods, there may be no provision of the good at all. Public goods have characteristics of non-rivalry, non-excludability. This means once provided, you can’t stop anyone using it. Therefore, there can be no incentive for a firm to provide it.
AQA do have a habit of asking questions on rather obscure terminology like composite demand, which many AS students haven’t heard and are not mentioned in some textbooks.