Exercises: Market failures

Explain what a market failure is and name four of its main types with a one-sentence example of each.

Distinguish between a negative externality and a positive externality, and classify these cases: smoke from a factory, childhood vaccination, a neighbor's loud music in the early hours of the morning, and a botanical garden open to the local neighborhood.

The figure represents the market for a product whose manufacture pollutes: it shows the private cost to producers and the social cost, which also includes the environmental damage suffered by third parties.

1. a) Identify which curve is which and explain the difference between private cost and social cost.
2. b) Compare the quantity produced by the market with what would be socially desirable and explain the difference.

Lighthouses and national defence are the classic examples of public goods.

1. a) Explain the two characteristics that define a public good.
2. b) Reason why a private firm would have difficulty selling these services: what does the 'free rider' problem consist of?

In the second-hand car market, the seller knows whether their car has hidden faults and the buyer does not.

1. a) Explain what this market failure is called and what consequences it has on prices and the quality of goods offered.
2. b) Propose two solutions, market-based or legal, that help reduce it.

There is only one pharmacy in a village.

1. a) Which market failure does this situation illustrate, and what might happen to prices and the quality of service?
2. b) What instruments does the government have to protect residents? Name two and explain them.

A paint factory dumps waste into the river: fish die, local farmers lose crops and water treatment is paid for by the municipality.

1. a) Analyze the externality: who generates it, who suffers from it and why the market alone does not correct it.
2. b) Compare two solutions: a tax on discharges or a regulation directly banning them.

A advocacy group argues in a public debate that childhood vaccination should no longer be free and should instead be funded entirely by users in the private market: “Each family knows its preferences and should pay the $\$80$ that the dose costs. If the market freely allocates vaccines according to supply and demand, the outcome will be optimal and we will save on taxes”. Epidemiologists warn that at this price, the coverage rate would fall from the current $96\ \%$ to $65\ \%$, whereas herd immunity to curb outbreaks requires at least $90\ \%$.

1. a) Refute the group's arguments using the concepts of marginal private cost, marginal social benefit, and free-rider behavior. Support your answer with conceptual graphical reasoning.
2. b) Predict the medium- and long-term economic consequences for the healthcare system and the country's productivity if this free-market proposal were to succeed.
3. c) Design and compare two avenues of public intervention to achieve a $95\ \%$ vaccination rate: one based on Pigouvian subsidies (free provision funded through general taxation) and another based on a restrictive legal rule (mandatory complete vaccination record to enroll in public and private schools). Assess the efficiency and equity of each.

In a large city, two digital delivery platforms account for $92\ \%$ of home delivery orders. They charge a $30\ \%$ commission to affiliated restaurants, unilaterally set rates for delivery riders, and run an opaque algorithm that penalizes the visibility of venues that do not purchase their extra advertising campaigns. To offset the commission, many restaurants have raised their menu prices by $15\ \%$ both for delivery and on-premise dining.

Faced with social unrest, the restaurant association presents two demands to the city council:

1. Legally cap the platforms' commission at $10\ \%$.

2. Create a free municipal public delivery platform funded by the municipal budget.

1. a) Analyze which market failures justify intervention in this sector (identify at least two among market power from network effects, information asymmetry, or switching costs).
2. b) Predict what unintended or counterproductive economic consequences capping the commission at $10\ \%$ would have on the supply of delivery riders, small suburban restaurants, and final prices.
3. c) Evaluate the proposal to create a municipal public platform: does it solve the problem, or does it generate potential government failures? Design a regulatory alternative that restores competition and transparency without distorting the market.