ACE8015.  Market Failures

Public Goods and Externalities & the Market Roles of Government


The most important forms or types of Market Failure affecting rural resources and the environment are: Both of these conditions mean, as we shall see, that the social (communal or collective) costs or benefits of an economic activity are not the same as the sum of private costs and benefits as accounted for in market transactions. The consequence is that the market can no longer be relied upon to generate a socially optimal allocation of resources to different forms of output, and hence cannot provide an optimal mix of end products. What do I mean by "socially optimal"?  That mix of products which properly reflects everyones' desires and wants, added up according to their willingness to pay, such that no one can be made better off without simultaneously making someone else worse off - the Pareto Principle for judging economic welfare.

Of course, this gives rise to another major reason for government intervention and regulation of the market system:  to alter and affect the distribution of income and wealth which the market generates, and the distribution of the economic activity which goes with it over the territorial space of the community - geographical distribution - so that the less well off have a greater weight (more income and/or more say) in determining what is produced (and where).  Remember the JUDGE function of governement at the beginning of this course (explained in the reference chapter for session 1)?  The Government as 'Judge' determines fair and just distributions of income, wealth, purchasing power, command over goods and services etc.  However, economics has nothing to say about the exercise of this function, other than to point out that any practical re-distribution typically reduces the efficiency of the market system by distorting the economic signals encouraging people to economise on scarce resources and adopt the most productive and efficient systems.

Remember the two other key functions of government?  Policeman - already implicit in the workings of the market system, since laws of contract and property rights are essential for markets to function. Pharmacist/Mechanic - which we have already seen something of under the heading of regulation of imperfect competition and monopoly, and under Macroeconomics - since this function is about making markets work better (that is, more efficiently - getting more out for what we put in).  Some brief concluding remarks are provided in this section on the pros and cons of the market system, which should tie in with the opening part of the course. In addition, these notes also link to the Climate Change Issue - and the question of Cost Benefit Analysis (CBA)

1. Public Goods 

For private goods (or services), my consumption, use or enjoyment denies you the use of the same unit - so my demand for the good or service competes with yours - we rival each other for the use of the product. The total demand for private goods is therefore the sum of the quantities each of us wishes to purchase at each price - we add up individual demand curves horizontally along the quantity axis. <>For Public Goods, however, my use, consumption or enjoyment does not deny you the use, consumption or enjoyment of the good - we are not rivaling each other for the use of the good (or service), so they are non-rival in consumption. An example is a football game or theatre performance - where, if anything, the more people who are enjoying or watching the performance, the greater the enjoyment of each person. So, how might we think if the total demand for a football game or theatre performance? Instead of adding up the quantity (1 or the length or the performance, game) for each person, we need to add up the price each person is willing to pay for the performance - we add up individual demands vertically, up the price axis, accumulating the total amount the audience is willing to pay for the same performance.

This example, however, illustrates that "non-rivalness" is not the only characteristic which separates public goods from private goods. In these cases, it is simple and easy to exclude people from the game or performance - we can stop people who have not paid from getting into the ground or theatre, and exclude them. For a public good, however, this is not possible - public goods are non-excludable as well as being non-rival. Examples include street lighting, lighthouses, national defence, public health (cleaner air, disease control etc.,) radio and TV broadcasts [though note here that it is possible, and now increasingly inexpensive, to exclude people - or at least fine them if they do not have the appropriate receiver license), and, importantly, the natural (or urban) environment. There are also such things as public bads - pollution is the classic example, which we will deal with below.

The market problem of public goods and a possible solution.

Why is the non-excludable characteristic a problem? Because if private (non collective) companies or organisations cannot charge people for their use, how are they going to raise enough revenue to pay the costs of providing these public goods? They cannot, other than relying on charitable (altruistic) donations from people who care about these goods. So, a simple-minded economist (who believes that people only do things for their own narrow self-interest) might argue that these public goods can never be provided by a free market. An "economically rational" individual would not spend hard earned income on public goods, since s/he would reason that others will provide the good anyway, and cannot exclude him or her from consumption or enjoyment once they do, so there is no point in contributing - better to "free-ride" on other (less economically rational) peoples' charity. If everyone behaved like this, no-one would get any public goods. Economics is, indeed, a dismal science.

There must be something wrong here, though. People do organise themselves to provide for at least some public goods. The lighthouses in the UK are run by Trinity House, which is an independent (private) organisation, paid for by contributions from mariners. The Royal National Lifeboat Institution (RNLI) is similarly a private charity supported solely by voluntary donations. Public service television stations in the US also exist and are succesful on the same principle. A lot of people are not quite so narrow-minded and stupidly selfish as the purely self-interested economically rational man - thank goodness.

Nevertheless, free-riding is a problem for many public goods. Unless everyone is forced to make a contribution (through taxes), the chances are that less of the public good will be provided than is socially optimal - that is, less than everyone is really willing to pay for the good, and hence a smaller or lower supply of the good than everyone really wants.   Thus, many public goods are paid for and provided by the Government, through coercion on the public's (yours and my) behalf. What do we mean by socially optimal?

Imagine, as a simple case, two people (households) interested in getting streetlights put into their private street (of just two houses). Both households have their own ideas about how much they are willing to pay for this common (public) service. One household (the most interested) could discover how much streetlighting would cost, and realise that it alone was not willing to pay the full amount. It might then approach the other and ask for a contribution towards the total cost. What would be the outcome of such negotiations?

The following diagram explains this and shows how (honest) negotiation between people could provide for the right amount of the public good that people want. This diagram may look seriously off-putting - but it is really quite straightforward - spend a little time and thought following through the explanation in the boxes - just get your brains into gear!  The outcome is that both households each contribute what they are willing to pay for street lights, and the combined amount is enough to cover the costs of supplying the amount (number) of streetlights that both households (collectively) are willing to pay for.  This is socially optimal for this community of two households.  If the costs were greater than the households willingness to pay, then too many street lights would be provided. If the costs were lower than the combined willingness to pay, then too few lights would be provided, since the users are colectively willing to pay for more.

The major problems with this concept of voluntary collective negotiation for the supply of public goods should be obvious (with a little thought). The solution requires that all the people interested in and benefiting from the public good are fully committed to the idea of collective action, and recognise that the solution will not work if people free-ride. This might be expected amongst a relatively small and coherent community (such as mariners for lighthouses and the RNLI for instance). Otherwise, as with the Royal Society for the Protection of Birds (RSPB), which (among other things) buys or rents wildlife reserves for the conservation of birds and thus related environments - as public goods -with voluntary donations and subscriptions, the organisation must put up with the near-inevitability that there will be substantial free-riding. Although the RSPB can, of course, exclude all but it own members from particular wildlife reserves, the general public cannot be excluded from the general good of encouraging wildlife. The National Trust is another example, albeit helped by the Her Majesty's Treasury in that large estates or country houses etc. can be left to the National Trust in lieu of estate duties, which would otherwise accrue to the Treasury as taxes.

Although the formal logic of this solution suggests that each contributor will pay a different price according to their own willingness to pay, the difficulties with this differential pricing solution in practice normally result in a standard contribution (membership fee, annual subscription etc.), though always allowing for the seriously altruistic or enthusiastic to contribute more if they like.

In some cases, it may be that a particularly rich or concerned member of the public might be prepared to pay for the public good on their own. This would follow from the above diagram if Dy intersected the supply curve (at C=MC=AC) - then the intersection would indacate the quantity Y would buy on his/her own, without support from the rest of the community. There is one classic case of this - the American media tycoon Ted Turner was so impressed with public service broadcasting (PSB, no adverts) that he bought his own PSB station in his home city of Atlanta. Once he had done so, of course, he was able to raise additional voluntary contributions from other residents, and thus extend the quality of the service. But this is a non profit making enterprise.

In general, however, for many public goods (National Parks, Environmentally Sensitive Areas, Areas of Outstanding National Beauty, national defence) it has been considered that the problem of free-riding is too great, and these public goods are provided by the Government and paid for out of general tax revenue, to which everyone is obliged to contribute according (roughly) to their means.  This, of course, requires some idea of how much people are actually willing to pay for the public goods in question, otherwise how does the government know how much of them to provide and how much to spend making them available?

See here for a short aside on the meaning of income elasticities for public goods.

Merit Goods (also publicly provided)

There is another class of goods (and especially services) provided from the public purse, though not principally because they are public (non-rival, non-excludable) goods. These merit goods -services - education, health service are classic examples, are considered by the public through their governments to be sufficiently important to everyone that they should be provided to all independently of their own ability or willingness to pay.

The issue here is that the market mechanism is capricious in the income (and wealth) distribution that it generates between people. The accidents of birth, personalities, family circumstances and local conditions all combine with the operation of the market system itself to ensure that incomes are never equal. Although most governments seek to rectify this somewhat with social security and progressive taxation systems (where the rich are supposed to pay more than the poor), the fact remains that some people will be richer than others, and thus have a generally greater willingness to pay. Social justice and equity demand, however, that some things are too important to be left to the market (even given that the poor are supported through income supplements of various sorts). For those interested, a thought-piece by your lecturer on the NHS might provoke some intelligent comment?

There are, however, some clear overlaps between merit goods and public goods. Some of our public goods (especially, perhaps, the natural environment in the form of National Parks etc.) are also considered to be merit goods. Our major merit goods (health, education) also have public good aspects - the better educated and the more healthy the population, the better-off everyone is, regardless of the indivudal level of health or education of each of us, simply because the economy and society is likely to work and perform better.

Nevertheless, it is helpful to keep the public good and merit good arguments separate when considering the problems of (for example) provision for conservation of the natural environment, or issues of the health and education services.

2. Externalities 

Externalities arise when the activity of one person, household or firm causes a loss or a gain to another, and where these losses or gains are uncompensated or unrewarded. If the gain or loss effects are comensated or rewarded, then we have a normal market transaction - externalities are those effects which are outside (external to) the market mechanisms of payments and contracts.

A typical example is pollution of air, water or soil, were the pollution is the unintended by-product of production which affects the value of the resource to other users or enjoyers, but which is not accounted for in the markets for either the production inputs and factors, or the markets for the products of the production process. Other relevant examples are pretty countrysides and wildlife, which are largely a consequence of farming practices in the UK, either producing these "by-products" or not, depending on the practices adopted.

These external effects are important because they mean that market transactions do not account for all the benefits and costs of particular activities, so the outcome of markets cannot ensure a social optimum. They arise because of two major factors:

Take as an example the case of pollution of a river by some production system (a dairy farm, if you like). If the farmer can produce without regard to the pollution he causes, he will maximise his private profits, since pollution control will generally cost money and reduce margins. There is, then, some upper bound to the level of pollution that this production activity will cause, consequent on the private profit maximising behaviour of the dairy farm. However, this level of pollution may well kill all the wildlife in the river, through atrophication. This damage will affect anglers, wildlife enthusiasts, water users downstream, ramblers etc., who value cleaner rivers and the benefits they enjoy from cleaner rivers.

We can picture the situation as in the following diagram.

The point of private profit maximisation is Qm. At this point (and corrpsonding production activity), the damage suffered by the river users and enjoyers is very substantial. On the other hand, there is a level of production and associated production practice which would eliminate the pollution entirely (shown by the intersection of the MD curve with the horizontal axis - implying in this illustration that some level and form of dairy farming is actually beneficial to the river environment).

Suppose that the farmer owns the river, and is alive to the business opportunities of the river. It might be worth his while to find out how much people were prepared to pay for enjoying or using the river. The answer would be that they would only be prepared to pay for a cleaner and less polluted river. The marginal damage (MD) curve shows how much they would be prepared to pay for a cleaner river, reading this curve from right to left, since it shows the monetary equivalent of the damage they suffer from the polluted river. They would be prepared to pay up to this damage suffered to avoid it (prefering to pay less of course). The sensible farmer would then negotiate with the potential users, agreeing to take steps to reduce pollution so long as the price paid for a cleaner river were greater than the reduction of net revenue earned from the farming operation as a result of reducing pollution. This reduction is shown by the MC curve, again reading from right to left. The final agreement between farmer and user would be at Q* pollution, with a payment of T* per uint of cleaner river by the users to the farmer.

What if the farmer does not own the river? Suppose the river is owned by someone else, who is also concerned about its value to them and other users. In this case, these owners can require the farmer to take steps not to damage their resource, and to pay compensation to the owners if such damage occured. The compensation required by the owners is shown, again, by the MD curve (reading from left to right) - a little compensation for a small amount of pollution and a lot for a large amount. What would now be the farmer's best option? Think, before you read on.

The farmer increases his private net revenues the more pollution he causes, but at a reducing rate, as shown by the MC curve, left to right. But he is now required to pay for this pollution at an increasing rate, according to the MD curve, left to right. The profit maximising optimum for the farmer is now where the reducing marginal benefit of polluting (the MC curve) crosses the increasing marginal cost to him of polluting - the MD curve. Once again, the market equilibrium solution (the optimum) is at pollution level Q* and the farmer paying T* per unit of pollution to the owners for the priviledge of polluting the river.

Conclusions on externalities

Thus, according to these principles, there does exist a logic which would allow for negotiations between owners and beneficiaries of a resource and polluters or damagers of (in effect using up) this resource to agree on an appropriate transaction and contract which balances the interests of the producers and users - allowing some pollution, but preventing levels of pollution where the gain from additional pollution is less than the cost of this additional pollution. In effect, our marginal damage curve above is the marginal social cost of pollution, while the marginal cost curve is the marginal social benefit of pollution (arising because of the useful and valuable things which are produced, but which also result in pollution).

This last remark might raise some eyebrows. The marginal net benefit of private production, however, is also a social benefit (reflecting the market demands for the product in question, milk and beef in this case). Of course, we can object that these markets are distorted by government policies and intervention, and thus do not properly reflect the social benefit of dairy farming. Quite right. The analysis above assumes that the markets for the products produced with pollution are perfectly competitive and not distorted.

The analysis also points up the often very serious difficulties with externalities. Three of the most important are as follows.


It is partly because of these difficulties, and also because the effects of pollution (or, more generally, environmental degradation) tend to be specific to particular locations and different between different locations and practices (that is, the effects are highly heterogeneous), that governments are asked (by their electorates, assisted by pressure groups) to intervene and find solutions to the externality problems. This analysis suggests that the appropriate solution is a system of pollution taxes or subsidies to avoid degradation. It can be shown that, under restrictive conditions, the tax/subsidy system is more efficient than regulation - blanket restrictions on levels of pollution and fines/penalties for contravention of the regulations (see here for a demonstration of this conclusion, and reasons why regulation might, nevertheless, be a preferable option in many cases, as is frequently observed in public opinion preferring regulation to taxes and subsidies).

 

Further Thoughts on Externalities and Public Goods:
Arising from an EU research programme on Animal Welfare (EconWelfare) which I become involved with recently.  [Reference: EconWelfare report, from which these notes come (see, also, a companion report on international trade implications)]

Two major questions arise:
 [Exactly similar questions might be asked about quite a lot of environmental goods and services (ecosystem services)]

While the conditions of animal welfare are, perhaps, a public good to the extent that whatever conditions of welfare exist, they exist for everyone, and no-one can be excluded, the conditions are not indivisible - all sorts of different animal welfare conditions exist, and the conditions which currently prevail are the consequence of two factors:

AW (Environmental) Regulations are the consequence of an ongoing political debate and decision-making process (what Stefan Mann calls a 'deliberative process') - , which essentially arbitrates between Animal Welfare advocacy groups on the one hand and producer interests on the other, since improved animal welfare (over and above what is commercially prudent) generally adds to production and supply costs, and reduces competitiveness versus less regulated suppliers. Unless consumers are willing to remain loyal to the products from better (more stringently regulated) animal welfare suppliers, i.e. willing to actually spend to improve welfare, they will take their business elsewhere, and the market will tend to 'race to the bottom' - attempts to improve animal welfare at home (beyond what domestic and other consumers are actually willing to pay for) simply export animal ill-fare abroad.  Hence, regulations can be expected to provide a minimum and most commonly acceptable level of animal welfare at home - and it is the regulation which is the public good, rather than the levels of animal welfare per se.  Regulation failure happens (in principle, and ceteris paribus) if consumer spending on local animal products fails to increase by at least enough to cover the costs of meeting (and policing) improved regulatory standards, following the introduction of the higher AW regulations - though this test might be very difficult to execute in practice, since the ceteris paribus conditions do not hold and are difficult to control for. In short, delegation of authority to politicians and government regulation for improved animal welfare does not abdicate citizens from their responsibilities as consumers to legitimise and justify the regulations on their behalf.

Consumers versus Citizens choices and intentions:  it is frequently observed that citizens 'votes' (repsonses to opinion poll surveys, or even to more sophisticated contingent valuation surveys or choice experiments) do not necessarily correspond to their actual purchasing behaviour - people do not generally put their money where their mouths are, either for animal welfare or, more generally, for environmental (CARE) goods and services.  Why not?  There are several sensible and justifiable answers, most of which do not constitute market failure.  This suggests that the possibility of regulatory failure is high (since, if there is no reason to suppose market failure, then regulations which intervene in the market process will 'fail' in the sense that society as whole would be better off in economic welfare terms without the imposed regulation).

The possible reasons for a citizen/consumer gap - a difference between voting or opinions about AW (or the environment) and spending patterns:
There are, in principle, six major reasons that can be attributed to people ‘voting’ for animal welfare improvements (expressing or reporting attitudes in favour of better animal welfare) but not actually purchasing more animal welfare friendly products, as shown in the Figure below.
The simplest (first) reason/excuse is that people are not actually prepared to pay the necessary premium for the more AW friendly products. Whatever their reasons, which are doubtless extremely complex, it is simply ‘cheap talk’ to vote for something for which one is not prepared to pay. If consumers to not exhibit or express any WTP for AW friendly products, markets cannot be expected to work. The fact that markets do not respond to attitudes or votes cannot be described, in itself, as ‘market failure’. 
However, there are several other reasons which can explain the difference between attitudes and exhibited WTP (i.e. actual purchase decisions).  The second reason identified in the Figure is that (some) people would be willing to pay the necessary premium if only they could be sure that their contribution to improved animal welfare would actually make a difference to animal welfare – one aspect of the free-rider problem. Since they cannot be sure that enough other people will pay enough to generate their preferred levels of welfare (environment), there is a reduced incentive for them to contribute themselves. The other, more common, aspect is that self-interested people will rely on others to pay the necessary premium, and simply free-ride on the outcome. In total (summed over the relevant population) the shortfall between peoples’ willingness to pay on their own account, and the amounts they would be willing to pay if they were convinced that their own spending was also matched by others, can be termed the ‘free-rider deficit’. In principle, if this deficit is greater than the amount necessary to encourage the supply or marketing chain to deliver the associated improvement in animal welfare (the ‘market deficit’), then society would be better off if the free-rider problem could be solved. On the other hand, if the free-rider deficit is not greater than the market deficit, then although there is a potential free rider problem, it does not result in any market failure – society would not be better off by ‘solving’ the problem – the costs of doing so would outweigh the benefits.
In practice, it is observed (e.g. Verbeke, 2010) that some people do appreciate the social pressures and norms encouraging them to spend their own money on improving animal welfare – hence both implicitly recognising and also dealing with the free-rider problem. “Some consumers reported a strong intention of purchasing sustainable dairy products, despite weak personal attitudes towards them. The explanation was found in those consumer’s social environments, where social pressure from peers acted as a purchasing motive. However, growing numbers of consumers are translating their citizen interest in animal welfare into purchasing intentions” (ibid. p 327). In effect, these people consider themselves part of a club or society in which the social pressures and norms are sufficient to persuade them to conform in spite of, rather than because of, their own self-interests. As societies spend more time and effort considering the present state of and possibilities for improving animal welfare, so people become more aware of the issues and more likely to respond to growing social pressures to support efforts to improve animal welfare. This ‘involvement’ of consumers with the products and their provenance, either directly or indirectly through social norms, can be improved, for some segments of the market, by improved communication and information, which effectively encourage people to join the ‘virtual’ clubs of those concerned about animal welfare. In short, simple economics, which assumes everyone is purely self-interested and rational, suggests that the free-rider problem could be substantial. In the real world, in which very few are simple homus economicus, and in which many are responsive to their peers and social norms, the free-rider problem may not be as significant. Social norms and values can certainly be cultivated and encouraged through active debate and provision of objective, disinterested information and validation services, which need to be provided through collective and collaborative action (governance), if not at public expense - an aspect of information and communication as a genuine public good.

[A practical and important aside: Actually measuring the free-rider deficit is fraught with serious, if not overwhelming, difficulty. It necessarily involves measuring willingness to pay as a pre-condition, and subsequently identifying the differences between this estimate with and without the condition that others are also both willing to and actually do pay their ‘share’. Since the questions eliciting peoples’ WTP are necessarily hypothetical – applying to conditions and circumstances which do not presently exist – the answers are always subject to hypothetical bias – people do not actually do what they say they will do, because ‘other things are not (and never are) equal’. Some analysts have gone so far as to argue that this hypothetical bias is sufficiently strong as to render all such ‘contingent valuation’ exercises effectively meaningless (e.g. Diamond and Hauseman, 1994). Others, e.g. Blamey et al., 1995, argue that people express different preferences for public (or club) goods than for private (normal) goods, and that the two sorts of preferences (and the associated decisions) are necessarily and conceptually distinct and non-commensurate – termed the ‘citizen hypothesis’. However, Curtis and McConnell (2002) using data involving preferences for deer culling programmes in the US, demonstrate that the citizen hypothesis is observationally equivalent to the ‘standard’ self-interested hypothesis augmented to include altruism. As Curtis and McConnell (ibid) note: “The citizen hypothesis is not empirically testable. It is a maintained hypothesis because the citizen hypothesis concerns the individuals' underlying motives and these motives are never conclusively revealed in actual behaviour or survey responses (p 72).
These authors go on to note that: “The impetus for the eco-labelling movement comes from the potential for individuals to combine their preferences for private and public goods. The consumption of all market goods has implications for the community, be it through employment, government services, morals or some other avenue. Altruistic motives provide a rational explanation of why self-interested people make choices that appear to be more beneficial to the community than to the individual. At least in the case we have studied, there is no difference in the WTP for respondents who could be reasonably classified as citizens and consumers" (p 81/2)].

Whether or not any substantial free-rider problem actually exists for animal welfare in Europe cannot simply be inferred from a difference between attitudes in favour of animal welfare and actual purchases of animal friendly products. The citizen-consumer gap also depends on the other reasons why citizens’ ‘voting’ (attitudes) in favour of improved animal welfare are not matched by their purchases as consumers.



MF&AW

The third reason (see Figure) is that the labelling of animal welfare friendly products is not sufficiently obvious or reliable to attract consumers or to convince them that their additional spending will have the desired effect of encouraging improved welfare. The fourth reason is closely related - that the information available to consumers about animal welfare and the improved standards used in producing some products is insufficient (or too contradictory or confusing) for them to make an informed choice. 
The appropriate remedies for each condition are obvious: improve the provision of disinterested (objective) information; use (disinterested) third party validation against proven standards; develop better and more reliable labelling procedures.  Many retailers consider that, while animal welfare standards are an interesting market niche, animal welfare as a stand-alone attribute is difficult to market separately from other quality characteristics, such as compliance with environmental standards or biodiversity, or organic production methods and systems. Nevertheless, especially in the UK, the Netherlands and Sweden, multiple retailers have already instituted animal welfare standards as part of their ‘premium’ product lines. The GLOBALgap standard, although not specifically identified on product labels, is increasingly being integrated into retailers supply chain management and branding. However, it is difficult for the concerned consumer (or their representatives and champions) to discover what these standards actually mean, since they are not (presently) always in the public domain. Furthermore, governments themselves may not always be considered the most reliable or credible sources of disinterested information, or the most effective communicators, and there is a clear role for third parties (including NGOs) in improving information and communication about animal welfare conditions and concerns (which might well qualify for public fund assistance on information and communication public good grounds). In addition, “consumers may use mistrust in information as an excuse of their unwillingness to change their purchasing behaviour in line with their alleged concerns” (Toma et al., 2011, p. 263), who go on to conclude from their study that their "results suggest that if a consumer is provided with adequate labelling of pork produced on farms certified to voluntarily not use gestation crates, we find no economic support justifying a ban on the use of gestation crates on the grounds of improving general consumer welfare.” (p. 724).
Tonsor and Wolfe (2011) also examine the question of whether or not labelling should be mandatory, rather than voluntary. "When initially asked, 61.7% and 62.0% (of the sample of 2001 US consumers) indicated they would be in favor of mandatory labeling of pork produced on farms using gestation crates and of eggs produced using laying hen cages, respectively. .. When follow-up questions directly referencing price implications were asked, many participants removed their support for mandatory labeling. In particular, 44.5%, and 43.8% of those supporting mandatory labeling of gestation crate and laying hen cage use, respectively, in the initial question, reversed their position and opposed the referendum when presented with price increases" (p432).  Their conclusions from this study provide a good summary statement of present socio-economic understandings of the issues: “Much research remains that would further improve our understanding of underlying demand (both of voters and meat consumers) for farm animal well-being, the implications for livestock producers, and the ultimate appropriateness of alternative regulatory environments in setting standards for the treatment of farm animals and the provision of such information to the general public" (p 435).

Improved communications, information and more reliable animal welfare labels, while obvious and useful, may not necessarily narrow the gap between attitudes and actions substantially. The fifth and sixth reasons for the disparity between reported attitudes/stated preferences and actual behaviour are probably more important (e.g. Verbeke, 2009). The fifth reason:  If consumers have to spend valuable time and energy searching for animal welfare friendly products, then the effective price of improved animal welfare rises and the demand falls.  Similarly, if other things (taste, quality, safety, convenience) are more important than the welfare provenance, then consumers will ration their time, effort and money in favour of these more important attributes, and not bother to seek out specific animal welfare friendly products. 
The sixth reason: Moreover, consumers (and citizens) are not only concerned about their food – they have plenty of other things to be interested in, worried and concerned about, and on which to spend their time, effort and money. They will, in other words, tend to be ‘rationally ignorant’ – not bothering to spend time and effort trying to find out about, or to find, animal welfare friendly products in the face of all their competing interests and (pre-) occupations. The benefits they would get from the effort are simply not worth it to them, though their responses in surveys will often be revealed as ‘being unable to find welfare friendly products’ and is often ascribed to be due to a ‘lack of availability’. It is also likely that at least some people would prefer not to be reminded about animal welfare at all when shopping for food. As a consequence, “Improved farm animal welfare is more likely be realised and valued by consumers when it is integrated within a broader concept of quality, such as quality assurance or sustainability schemes” (ibid, p. 325). 

Notice that both attitude surveys and typical WTP studies, being focused on the specific issue of animal welfare, in isolation from the real world, do not include these real world constraints and considerations, and are always and necessarily biased in favour of the focussed issue as a result.  Isolated attitudes are not likely to be reliable indicators of purchase intentions or actions, as is frequently found in the literature. Considering all the potential reasons why consumers’ behaviour might well differ from their stated attitudes (‘votes”) in favour of animal welfare as citizens, it should come as little surprise that there is a gap between attitudes and behaviour. Indeed, what is perhaps more surprising is that the gap is not larger. The apparent gap does not necessarily justify specific government action to bridge the gap, but the analysis of the reasons for the gap does indicate the roles, and likely effectiveness of information, communication, verification, disinterested standard setting and associated labelling support activities, and also indicate that public-private partnerships are likely to prove most effective.

3. Concluding Remarks on the market system. 

The issue of environmental conservation (and its opposite - pollution and degradation) shows that the market system evolves and develops in response to changing supply and demand conditions. Immediately after the second war, people in the UK were much more concerned about food security than about the natural environment, and agriculture was encouraged and supported almost regardless of the consequences for the environment (which was largely treated as a free good).

As concerns over food security diminished, and people became richer and more leisured, so the demands for countryside and wildlife increased (witness the growth in membership and subscription to the environmental and wildlife pressure groups and action organisations like the RSPB). So, too, does public support for the policies of agricultural protection and subsidy diminish, leading to changes in the government (public) policies with these objectives, as well as to changes in market signals and thus responses of both the supply and the demand sides of the market. The growing demand for organic and environmentally freindly food production is having an effect in the market, encouraging more of these production practices, as well as generating pressure for government legislation and policies.

The market system, in spite of its apparent concentration on pure self-interest, does generate responses to changing circumstances and conditions and encourage socially acceptable solutions - albeit not nearly fast enough or effectively enough for some peoples' tastes. It is a serious mistake, though, to consider government or state action and management of the social and economic system as an alternative to the market system. Both require each other.

Markets need to take account of public opinions and values, or the public will find ways (through government or through their own purchasing and factor supply decisions) to make markets behave better. But governments (and the general public) need also to take account of the expressions of self-interest and self-determination as expressed in market transactions, otherwise their attempts at governance and regulation are quite likely to result in worse rather than better outcomes. Adam Smith's invisible hand is inevitably attached to the long arm of the law - to enforce market contracts and protect property rights, and also to try and correct the market-determined income and wealth distributions between people so that they accord more clearly with public perceptions of social justice.

The key difficulty, here, is that interference with the market distribution will tend to change incentives and market signals, and make the market work less well than if there is no interference. If income (and associated consumption) and profit are the only motivators of human activity, then this adverse effect on the market might be serious. However, there is both good reason and substantial evidence that people do things for reasons other then pure economic self-interest (though these other motivations and behaviours have not yet been incorporated into the economic models and pictures of behaviours).

A note on the Meaning of "Competitive Markets" in the textbooks
The typical textbook definition of perfect competition includes:

We have already dealt with all of these conditions except the first.  We have seen (under monopoly) how restricted entry to markets creates monopolies ( a single seller), and the possibility of supernormal or monoply profits.  And we have seen how the operation of market competition for these profits is likely to errode the profit.  We have seen how markets tend to deal with homogenous products - by differentiating them, to produce monopolistic competition.  And we have just dealt with the issues arising from private costs and benefits differing from their public or social counterparts - the market failures of public goods and externalities, and we have seen that, at least in principle though not so easily in practice, it is possible for people to get together and sort out these problems for themselves - through market transactions and contracts - on the basis of trades and trade-offs between what we want and what we can get.

What about Perfect information?  Clearly the concept of completely perfect information is perfectly stupid - no-one can know the future, so information can never be perfect since it cannot include fore-knowledge. The collection and organisation of information, so that it can be used to generate knowledge, is (at least in part) an economic activity - it uses and needs time, effort and resources, so will cost somebody something for which they will need to be re-imbursed, otherwise they will not be able to continue doing it. So perfect information cannot mean that it is free either. So what do we mean by perfect information?

Essentially, we mean that all sides of the market (buyers and sellers and traders) have equal access to all the available information relating to the market and its supply and demand conditions. Whether or not all sides of the market then choose to make use of this information, and how individuals or firms choose to use it, is then up to them. However, those who make the best use of the available information (in the sense that they use it to better understand the consequences of their and others actions) will tend to prosper, while those who choose to ignore it will tend (except by fortunate accident) to do less well. So long as information on who is doing well and the ways in which they are using the information are common knowledge, then there is a built-in incentive to both follow best practice and to cooperate (trade) in information.

Collusion and exclusion of people or firms from the information pool (which is frequently attempted by some in order to enhance their own position relative to others) is thus judged by this criterion to be anti-competitive. Note, here, that some commentaries and analyses of competitiveness seem to imply that protection of information (exclusion of potential competitors from your own knowledge) is an important source of competitive advantage (not to be confused with comparative advantage). The argument here is that this activity is contrary to perfect competition, and therefore should be regarded as a form of market failure.  Governments should take all possible steps to ensure that information is freely available to all.

However, this gives rise to very substantial problem - information is a Public Good - my use of it does not deny you the use of the same information, and excluding you from its use amounts to a market failure.  So, we need cooperative and collective decisions to spend the time and resources necessary to generate information and organise it into knowledge.  Which seems to mean that we will need government to help us do this.  Privatisation of information is bad news for competition, and is bad news for the proper functioning of markets.  Yet much of our market systems rely on people and firms laying personal or private claim to information and knowledge - patents, copyrights, intellectual property rights (as they are frequently called) - as licences to earn supernormal profits, justified on the grounds that it costs money and resources to produce it.  I regard this as the critical problem of our modern economies, but you will not find it much discussed in most of the introductory economic textbooks.

In short - the traditional textbook definition of perfect competition is rather meaningless - it is not perfect in any sensible sense of the word, and it is incomplete as an explanation of competition.  So why does it persist?  Because it allows for the more or less exact (mathematical) definition of a particularly abstract and very simple economy, from which some more or less rigorous conclusions can be drawn, most of which have very little relevance to the real world.  Which is why these notes pay limited attention to the notion of perfect competition. 


What should you have learned from this section? Final Point:  These so-called market failures might equally well be termed public choice failures or political failures.  The fact that the market mechanisms do not take full account of either the value of public goods or of externalities can be interpreted as saying that the benefits of trying to account for these features of our economic activity simply do not outweigh the very considerable transaction and decision making costs associated with finding their solution - hence markets do not bother to try and solve them - the effort is not worth while.  If this is true, then the real challenge is to encourage more participatory democracy - more collective involvement in public decisions - to reduce the transaction and decision making costs, and very possibly improve the quality of public decisions.  For examples of what this might mean in practice, see the UN Local Leadership Programme - especially their Best Practice - Good Urban Governance Theme.

SO - WHAT ARE WE SUPPOSED TO DO ABOUT THESE 'FAILURES'?  - ESPECIALLY CLIMATE CHANGE - THE MAJOR CHALLENGE FACING HUMAN SOCIETY?  - SEE HERE FOR SOME DISCUSSION.


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