Haze and its Negative Externalities

1. What is the meaning of market failure?

The word ‘market’ refers to capitalist/ free market/ market economy while the word ‘failure’ means not functioning well. Putting it all together, in a way that is much easier to understand is the free market economy fails to function properly/ has too many problems. This is the layman way of understanding. I always tell my students not to be afraid with all these economics jargon. In fact most of them can be easily understood and remembered, so long as we try to understand them PART-BY-PART

The more technical definition would be the interaction of price mechanism / demand and supply fails to allocate economic resources in the most efficient way resulting in net welfare loss (more costs than benefits)

2. What are some of the examples of market failure?

Before getting there, we need to basically understand the essence of a market economy. Under such system, it is always assumed that the role of government is limited or perhaps to some degree none. Cash is king and those who are able and willing to pay will decide how the scarce economic resources will be directed to provide what they want. Consumers just want to maximise their utility (satisfaction). Meanwhile, firms are crazy over figures e.g. lowest cost and highest price possible to widen their margin of profits. The most responsive ones in a dynamic business environment will thrive while those which are slow to react will slowly perish

These have often caused some goods and services to be either under provided and hence under consumed or over provided and hence over consumed. In one or two cases, some goods/ services are not even provided despite it bring economic benefits

Consider merit goods/ goods that create positive externalities like education and healthcare. In a free market, these two will only be provided to a small group of consumers who are willing and able to pay for it, despite some argue that they are both universal rights and shouldn’t be abused to that extent. Now, I hope you can see why private colleges and hospitals are so expensive. Fees and charges are often revised upward between 5%-10% on annual basis. If there is no government intervention to fix such market failure, knowledge and health inequality between the rich and poor would have widened

Now, consider demerit goods/ goods that create negative externalities such as cigarettes, alcohol and fatty foods. In a free market, cigarette manufacturers will only consider their profits and nothing else. They will go to all extent to push young adults to indulge in smoking despite its costs far outweigh its benefits. They are not concern with consumers’ health, risks of fire in the building, litters all over the place and many more. Equally, McDonalds cares very little over issues like obesity, heart failure, diabetes and others. Profit is number one goal. This explains why the government needs to intervene with measures like awareness campaign and fatty tax

There are obviously many more problems e.g. absence of public goods, income inequality, information failure, private monopolies and others. I will talk about these in other posts

3. What about the recent haze in Singapore and Malaysia?

The haze which peaked in early July 2013 is a perfect example of negative externality/ external cost. It is defined as a negative third party effect/ spill over from production/ costs which the price mechanism fails to take into account or social costs minus private costs

We didn’t start the forest burning but since our neighbour is so insensitive, eventually we are affected by it too. The private cost (PC) to firms involved is technically zero since it costs nothing other than to start with a small fire. The external costs (EC) are tremendous especially to Singapore which is closer to the Indonesia. Health problem e.g. respiratory illnesses will escalate, tourists will temporarily shy away and spend their money elsewhere, hotels getting all the booking cancellation and street food operators are all affected because people choose to spend more time indoor. If this persist for a quarter (July-September), then I wouldn’t be surprised that the Singapore’s national income will contract this financial year

4. How can this be illustrated on a cost-benefit diagram?

Private firms will only take into account their own private benefits and private costs when they operate. This is why open burning is so rampant at Q1 where MPB = MPC. However, from the society’s point of view open-burning is a public nuisance and therefore should be reduced to a more tolerable level which is Q2 where MSB = MSC. Welfare loss is resulted as can be seen from the shaded red triangle. This is because there is an over-production of haze by the amount of Q1Q2. We assume that there are no external benefits involved and so MEB = 0. This explains why the MPB = MSB. The purpose is to make the analysis simpler. In reality, there are external benefits e.g. higher profits to the private hospitals and of course masks provider