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how do you define market failure? if i were to say that market failure refers to the free market being unable to achieve economic(allocative and productive) efficiency in the absence of govt intervention then for the case of income inequality, is it considered a market failure? (given that the market does allocate resources efficiently except that it isn’t a satisfactory allocation. :/
Defining Market Failure
Market failure in the H2 context specifically refers to the unfettered free market failing to achieve allocative efficiency. In most other contexts (including at the university level), market failure refers to the free market failing to achieve pareto efficiency. If we follow the latter definition, then income inequality DOES NOT lead to market failure.
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We discussed a highly simplified example yesterday. We made our lives easy with a key assumption:
You have already paid for the food in advance and thus there is no opportunity cost.
Let’s change the problem slightly. Suppose now you are in an Ala Carte restaurant, how do you decide how much to order and eat?
This next part is going to be a bit counter-intuitive, so follow me closely.
To solve this problem, we need to answer the following question:
All of us have been to buffets.
Imagine that you’ve paid for one of your favourites, and now you are in.
How do you decide how much to eat?
To simplify the problem, let’s assume there’s only one type of food. Your benefits curve is probably going to look something like the following.
Initially as you first start eating, you feel really good and thus the total benefit increases rapidly. As you eat more and more, you start getting a little full and that succulent slice of sashimi just doesn’t taste as nice as it did at the start. You are still benefiting from eating more, but just less than before.