CGMA BA1

2. The market system

2.2. Supply

Our CGMA course is currently in development and is a work-in-progress.

Market failures and government intervention

7 min read

Markets don’t provide everything an economy needs. Some people are too poor to afford basic goods, and some services and products are too complicated or dangerous to be provided efficiently by the market.

Public goods

Definitions

Public goods: Goods where one person’s consumption doesn’t reduce another person’s consumption, and they are free.

One example is public goods, which the market often doesn’t provide because there is no competitive advantage or benefit in doing so.

Example:

Public goods include police, army, streetlights, and national roads.

Externalities

Definitions

Externalities: Benefits or costs that are not included in the demand or supply curve but still affect consumers and society.

Externalities are called externalities because they involve costs or benefits that the market does not account for. As a result, these costs or benefits are often borne by the public or the government instead. Externalities are grouped into two types: positive externalities and negative externalities.

Positive externalities include schools built by a mining company in the community from which it extracts minerals, infrastructure, and roads being constructed for the same reasons.

Example:

A manufacturing company may build a training center for short courses for those who wish to work in the mining industry. These are positive externalities that result from market activity, but note that they benefit the public at the expense of the company.

Negative externalities include road accidents caused by drunk drivers, contamination of land and water sources from dumps being made by factories, noise pollution from airports, and more.

Example:

These costs are carried by the public and government while the company bears zero cost of that. The government can introduce some laws and some indirect taxes to reduce the effects of the negative externalities.

Merit and demerit goods

Definitions

Merit goods: Goods that should be available to all, even though the market can provide them.
Demerit goods: Goods or services that are viewed negatively because of their effects.

Merit goods are sometimes confused with public goods. Examples include education and medical care.

Education: which also can be provided by the market
Medical care: which also can be provided by the market

The reason why these goods are provided by the government is because when the market is involved not everyone can benefit since everything is expressed in financial terms.

Demerit goods include alcohol, tobacco, drugs and more.

Example:

The government tries to implement control on their consumption. For example, in most countries alcohol is not allowed to be consumed by children under $18$ and smoking and drinking is prohibited in public transport or public places.

Regulation of markets

This is an important part of every jurisdiction in an attempt to:

Create a fair competition: avoid monopoly
Fair prices for consumers: set maximum and minimum prices on certain products
Safe and harmless products: set quality standards for certain products
And more

Maximum pricing

Maximum pricing is when the government sets the highest legal price for a product to protect consumers. This is normally done on basic goods, e.g., bread, coffee, etc., to make sure that all consumers can have those goods.

For a maximum price to be effective, it has to be set below the equilibrium point. Maximum pricing can be used to encourage the consumption of goods that are in less demand.

The results of maximum pricing are:

Shortage of supplies
Decline in the market with maximum pricing due to lower profitability
Misallocation of resources

Example:

If the equilibrium is $$20$ , setting a maximum price of $$30$ won’t change anything because the market price is already below that. But setting the maximum price at $$15$ will have an impact because suppliers are forced to sell below the equilibrium price, which increases quantity demanded.

Minimum pricing

Minimum pricing is when the government sets the lowest legal price for a product. It may be used to limit consumption of dangerous goods, or to encourage supply in industries that have fewer production factors.

For a minimum price to be effective, it has to be set above the equilibrium point.

The results of minimum pricing are:

Excess in supply because suppliers have an incentive to produce more.
Wastages e.g. more products being dumped because of low consumer rate.
Misallocation of resources with more suppliers leaving their respective industries to join the one with a higher profit leaving other areas unattended.

Example:

If the equilibrium point is $$20$ , setting the minimum price at $$30$ makes the product more expensive and limits demand. It can also encourage suppliers to supply more because profit per unit is higher. But setting the minimum price at $$15$ won’t have an effect because the market price is already above that.

Economies of scale

Definitions

Economies of scale: A decrease in unit production cost due to an increase in production volume. This can happen because of savings when bulk production takes place.

As production increases, businesses can spread their fixed costs over more units and take advantage of efficiencies such as bulk buying, improved technology, and specialization of labor. This leads to a lower cost per unit, which can increase profitability and competitiveness.

Economies of scale can be classified as either internal or external.

Internal economies of scale

Internal economies of scale are enjoyed by one company, meaning they cannot be shared with other companies.

Technical economies: This is the ability of a company to produce in bulky due to the high level of demand, which will lead to more savings since production is being done in huge quantities.

Example:

A small company might buy a large-scale machine but won’t be able to use it efficiently because it doesn’t have enough demand to justify the machine.

Trading economies: These are advantages enjoyed by a large company due to its positioning in the market.

Example:

A company may be known for selling in bulky, which might reduce selling costs. Some companies also use dealerships / sales agents / purchasing agents to handle complications and get better deals, which is often unrealistic for a small company because of lower production and the inability to afford such privileges.

Financial economies: Big companies can borrow large stocks / loans and often have more security to borrow against.

Example:

Their credit score could be exceptional, meaning they may borrow at a lower rate of interest. This is often not the case for small companies, which may not be able to borrow large loans or provide strong security.

Managerial economies: A type of internal economy of scale where larger firms can spread the cost of experienced managers over a greater number of employees or operations, reducing the average cost per unit.

Example:

In large companies one manager can oversee $200$ employees, meaning the cost of one manager is shared by $200$ employees. In small companies one manager might oversee, say, $10$ employees, which makes employing a manager more expensive per employee.

External economies

These are economies of scale enjoyed by multiple companies, usually because they operate in the same area or have access to the same shared advantages.

Example:

Mining companies in a rural area may all benefit from cheap labor. Car manufacturing companies in German might save on training costs since the area is rich in technical knowledge about cars and electronic devices. So long as a company is in the same location or has access, it can benefit.

Diseconomies of scale

These happen when increasing production leads to higher unit costs. This can occur when a company becomes too large to manage efficiently, leading to issues such as poor communication, delays in decision making, and reduced coordination between departments.

As production continues to grow, costs such as administration, supervision, and maintenance may increase faster than the benefits gained from producing in bulk. This results in a higher cost per unit rather than a lower one.

It is the company’s responsibility to determine at what production level economies of scale end to avoid running into diseconomies of scale.

We mentioned trading, technical, financial and managerial diseconomies, overdoing these could lead to diseconomies of scale.

Example:

A company might produce in bulk and receive discounts, but storage facilities and machinery maintenance might end up costing more than the savings made.

Next | 2.2.2 Supply, elasticity, and market equilibrium

Market failures and government intervention

Public goods

Definitions

Public goods: Goods where one person’s consumption doesn’t reduce another person’s consumption, and they are free.

One example is public goods, which the market often doesn’t provide because there is no competitive advantage or benefit in doing so.

Example:

Public goods include police, army, streetlights, and national roads.

Externalities

Definitions

Externalities: Benefits or costs that are not included in the demand or supply curve but still affect consumers and society.

Positive externalities include schools built by a mining company in the community from which it extracts minerals, infrastructure, and roads being constructed for the same reasons.

Example:

A manufacturing company may build a training center for short courses for those who wish to work in the mining industry. These are positive externalities that result from market activity, but note that they benefit the public at the expense of the company.

Negative externalities include road accidents caused by drunk drivers, contamination of land and water sources from dumps being made by factories, noise pollution from airports, and more.

Example:

These costs are carried by the public and government while the company bears zero cost of that. The government can introduce some laws and some indirect taxes to reduce the effects of the negative externalities.

Merit and demerit goods

Definitions

Merit goods: Goods that should be available to all, even though the market can provide them.
Demerit goods: Goods or services that are viewed negatively because of their effects.

Merit goods are sometimes confused with public goods. Examples include education and medical care.

Education: which also can be provided by the market
Medical care: which also can be provided by the market

The reason why these goods are provided by the government is because when the market is involved not everyone can benefit since everything is expressed in financial terms.

Demerit goods include alcohol, tobacco, drugs and more.

Example:

The government tries to implement control on their consumption. For example, in most countries alcohol is not allowed to be consumed by children under $18$ and smoking and drinking is prohibited in public transport or public places.

Regulation of markets

This is an important part of every jurisdiction in an attempt to:

Create a fair competition: avoid monopoly
Fair prices for consumers: set maximum and minimum prices on certain products
Safe and harmless products: set quality standards for certain products
And more

Maximum pricing

For a maximum price to be effective, it has to be set below the equilibrium point. Maximum pricing can be used to encourage the consumption of goods that are in less demand.

The results of maximum pricing are:

Shortage of supplies
Decline in the market with maximum pricing due to lower profitability
Misallocation of resources

Example:

If the equilibrium is $$20$ , setting a maximum price of $$30$ won’t change anything because the market price is already below that. But setting the maximum price at $$15$ will have an impact because suppliers are forced to sell below the equilibrium price, which increases quantity demanded.

Minimum pricing

For a minimum price to be effective, it has to be set above the equilibrium point.

The results of minimum pricing are:

Excess in supply because suppliers have an incentive to produce more.
Wastages e.g. more products being dumped because of low consumer rate.
Misallocation of resources with more suppliers leaving their respective industries to join the one with a higher profit leaving other areas unattended.

Example:

If the equilibrium point is $$20$ , setting the minimum price at $$30$ makes the product more expensive and limits demand. It can also encourage suppliers to supply more because profit per unit is higher. But setting the minimum price at $$15$ won’t have an effect because the market price is already above that.

Economies of scale

Definitions

Economies of scale: A decrease in unit production cost due to an increase in production volume. This can happen because of savings when bulk production takes place.

Economies of scale can be classified as either internal or external.

Internal economies of scale

Internal economies of scale are enjoyed by one company, meaning they cannot be shared with other companies.

Technical economies: This is the ability of a company to produce in bulky due to the high level of demand, which will lead to more savings since production is being done in huge quantities.

Example:

A small company might buy a large-scale machine but won’t be able to use it efficiently because it doesn’t have enough demand to justify the machine.

Trading economies: These are advantages enjoyed by a large company due to its positioning in the market.

Example:

A company may be known for selling in bulky, which might reduce selling costs. Some companies also use dealerships / sales agents / purchasing agents to handle complications and get better deals, which is often unrealistic for a small company because of lower production and the inability to afford such privileges.

Financial economies: Big companies can borrow large stocks / loans and often have more security to borrow against.

Example:

Their credit score could be exceptional, meaning they may borrow at a lower rate of interest. This is often not the case for small companies, which may not be able to borrow large loans or provide strong security.

Example:

In large companies one manager can oversee $200$ employees, meaning the cost of one manager is shared by $200$ employees. In small companies one manager might oversee, say, $10$ employees, which makes employing a manager more expensive per employee.

External economies

These are economies of scale enjoyed by multiple companies, usually because they operate in the same area or have access to the same shared advantages.

Example:

Mining companies in a rural area may all benefit from cheap labor. Car manufacturing companies in German might save on training costs since the area is rich in technical knowledge about cars and electronic devices. So long as a company is in the same location or has access, it can benefit.

Diseconomies of scale

It is the company’s responsibility to determine at what production level economies of scale end to avoid running into diseconomies of scale.

We mentioned trading, technical, financial and managerial diseconomies, overdoing these could lead to diseconomies of scale.

Example:

A company might produce in bulk and receive discounts, but storage facilities and machinery maintenance might end up costing more than the savings made.

Public goods

Definitions

Public goods: Goods where one person’s consumption doesn’t reduce another person’s consumption, and they are free.

One example is public goods, which the market often doesn’t provide because there is no competitive advantage or benefit in doing so.

Example:

Public goods include police, army, streetlights, and national roads.

Externalities

Definitions

Externalities: Benefits or costs that are not included in the demand or supply curve but still affect consumers and society.

Positive externalities include schools built by a mining company in the community from which it extracts minerals, infrastructure, and roads being constructed for the same reasons.

Example:

A manufacturing company may build a training center for short courses for those who wish to work in the mining industry. These are positive externalities that result from market activity, but note that they benefit the public at the expense of the company.

Negative externalities include road accidents caused by drunk drivers, contamination of land and water sources from dumps being made by factories, noise pollution from airports, and more.

Example:

These costs are carried by the public and government while the company bears zero cost of that. The government can introduce some laws and some indirect taxes to reduce the effects of the negative externalities.

Merit and demerit goods

Definitions

Merit goods: Goods that should be available to all, even though the market can provide them.
Demerit goods: Goods or services that are viewed negatively because of their effects.

Merit goods are sometimes confused with public goods. Examples include education and medical care.

Education: which also can be provided by the market
Medical care: which also can be provided by the market

The reason why these goods are provided by the government is because when the market is involved not everyone can benefit since everything is expressed in financial terms.

Demerit goods include alcohol, tobacco, drugs and more.

Example:

The government tries to implement control on their consumption. For example, in most countries alcohol is not allowed to be consumed by children under $18$ and smoking and drinking is prohibited in public transport or public places.

Regulation of markets

This is an important part of every jurisdiction in an attempt to:

Create a fair competition: avoid monopoly
Fair prices for consumers: set maximum and minimum prices on certain products
Safe and harmless products: set quality standards for certain products
And more

Maximum pricing

For a maximum price to be effective, it has to be set below the equilibrium point. Maximum pricing can be used to encourage the consumption of goods that are in less demand.

The results of maximum pricing are:

Shortage of supplies
Decline in the market with maximum pricing due to lower profitability
Misallocation of resources

Example:

If the equilibrium is $$20$ , setting a maximum price of $$30$ won’t change anything because the market price is already below that. But setting the maximum price at $$15$ will have an impact because suppliers are forced to sell below the equilibrium price, which increases quantity demanded.

Minimum pricing

For a minimum price to be effective, it has to be set above the equilibrium point.

The results of minimum pricing are:

Excess in supply because suppliers have an incentive to produce more.
Wastages e.g. more products being dumped because of low consumer rate.
Misallocation of resources with more suppliers leaving their respective industries to join the one with a higher profit leaving other areas unattended.

Example:

If the equilibrium point is $$20$ , setting the minimum price at $$30$ makes the product more expensive and limits demand. It can also encourage suppliers to supply more because profit per unit is higher. But setting the minimum price at $$15$ won’t have an effect because the market price is already above that.

Economies of scale

Definitions

Economies of scale: A decrease in unit production cost due to an increase in production volume. This can happen because of savings when bulk production takes place.

Economies of scale can be classified as either internal or external.

Internal economies of scale

Internal economies of scale are enjoyed by one company, meaning they cannot be shared with other companies.

Technical economies: This is the ability of a company to produce in bulky due to the high level of demand, which will lead to more savings since production is being done in huge quantities.

Example:

A small company might buy a large-scale machine but won’t be able to use it efficiently because it doesn’t have enough demand to justify the machine.

Trading economies: These are advantages enjoyed by a large company due to its positioning in the market.

Example:

A company may be known for selling in bulky, which might reduce selling costs. Some companies also use dealerships / sales agents / purchasing agents to handle complications and get better deals, which is often unrealistic for a small company because of lower production and the inability to afford such privileges.

Financial economies: Big companies can borrow large stocks / loans and often have more security to borrow against.

Example:

Their credit score could be exceptional, meaning they may borrow at a lower rate of interest. This is often not the case for small companies, which may not be able to borrow large loans or provide strong security.

Example:

In large companies one manager can oversee $200$ employees, meaning the cost of one manager is shared by $200$ employees. In small companies one manager might oversee, say, $10$ employees, which makes employing a manager more expensive per employee.

External economies

These are economies of scale enjoyed by multiple companies, usually because they operate in the same area or have access to the same shared advantages.

Example:

Mining companies in a rural area may all benefit from cheap labor. Car manufacturing companies in German might save on training costs since the area is rich in technical knowledge about cars and electronic devices. So long as a company is in the same location or has access, it can benefit.

Diseconomies of scale

It is the company’s responsibility to determine at what production level economies of scale end to avoid running into diseconomies of scale.

We mentioned trading, technical, financial and managerial diseconomies, overdoing these could lead to diseconomies of scale.

Example:

A company might produce in bulk and receive discounts, but storage facilities and machinery maintenance might end up costing more than the savings made.