What this lesson teaches
I can state a government's two microeconomic objectives: efficiency and equity.
Syllabus 8843, 2.2.1(a). Governments' Microeconomic Objectives: Governments' microeconomic objectives are efficiency and equity
I can explain that a market is efficient at the social optimum, where marginal social benefit equals marginal social cost.
Syllabus 8843, 2.2.1(b). Governments' Microeconomic Objectives: Efficiency in markets occurs when the social optimum is achieved, where Marginal Social Benefit (MSB) = Marginal Social Cost (MSC), maximising society's welfare
I can explain why an efficient outcome can still be unfair.
Syllabus 8843, 2.2.1(d). Governments' Microeconomic Objectives: Efficient resource allocation may not result in equitable outcomes
I can explain equity as a fair share of essential goods and services.
Syllabus 8843, 2.2.1(e). Governments' Microeconomic Objectives: Equity occurs when there is fairness in the distribution of essential goods and services
I can define market failure as the free market failing to allocate resources efficiently.
Syllabus 8843, 2.2.2(a). Market Failure and its Causes: Market failure occurs when the free market is unable to allocate resources efficiently
Make a guess
A market produces exactly the efficient amount of dental care, but many low-income families cannot afford it. Has the market failed?
- No. The quantity is efficient; affordability is an equity issue.
- Yes, because dental care should be free for everyone.
- Yes. A market that prices low-income families out has failed, whatever the quantity.
Show the answer
No. The quantity is efficient; affordability is an equity issue.
Market failure means the wrong quantity. Who can afford the good is a question of fairness, which needs a different kind of policy.
Markets fail when they do not allocate resources efficiently; equity is a separate question about fairness.
Allocative efficiency means producing the quantity where society's net benefit is greatest. This is where marginal social benefit equals marginal social cost (MSB = MSC).
Market failure happens when a free market does not reach that point, so resources are misallocated. The causes in this chapter are externalities, public goods and information failure.
Equity is about fairness in how income and goods are shared. A market can be efficient and still leave some people unable to afford essentials such as healthcare.
So there are two reasons governments step in: to correct inefficiency, and to make outcomes fairer. Be clear which one you are discussing.
- Efficient
- MSB = MSC.
- Equity
- Fairness in distribution: a separate question.
Worked example: Efficient, but not affordable for all
A clinic service is supplied at the output where MSB = MSC. Some low-income households still cannot afford it.
- The output is efficient: the last unit's social benefit equals its social cost.
- But some households are priced out, so the outcome may be seen as unfair.
- The fix is not a market failure policy but an equity policy, such as targeted subsidies like CHAS in Singapore.
Watch out for this
If some people cannot afford a good, the market has failed.
That is an equity concern. Market failure is about an inefficient quantity. The two can occur together, but they are different problems.
Check your understanding
What does allocative efficiency require?
- The largest output the economy can produce, with no resources left idle.
- Output where marginal social benefit equals marginal social cost.
- Output at a price that low-income households can afford.
Show the answer
Output where marginal social benefit equals marginal social cost.
Right. At that point, society gains the most net benefit.