Implications of misallocation of resources in relation to the non-provision of public goods

1. The Basic Economic Problem

• Scarcity: Unlimited wants but limited resources → societies must make choices.
• Factors of production: Land, labour, capital, enterprise.
• Opportunity cost: The next‑best alternative fore‑gone when a choice is made.

1.1 Production Possibility Curve (PPC)

Shows the maximum combinations of two goods that can be produced when all resources are fully and efficiently employed.

• Points on the curve – efficient production.
• Points inside the curve – under‑utilisation or misallocation of resources.
• Points outside the curve – unattainable with current resources.

2. Allocation of Resources

2.1 The Market‑Economic System (Price Mechanism)

• Consumers (households) and producers (firms) interact through price signals.
• Prices coordinate the allocation of scarce resources.
• When the price mechanism works well the outcome is usually efficient (Pareto optimal).

2.2 Demand and Supply

• Demand: Quantity buyers are willing & able to purchase at each price.
• Supply: Quantity sellers are willing & able to sell at each price.
• Market equilibrium: Where D = S; determines market price (P_e) and quantity (Q_e).
• Shifts in demand or supply change equilibrium price and quantity.

2.3 Elasticities

2.4 Types of Markets

2.5 Market Failure

Occurs when the free market does not achieve an efficient allocation of resources.

• Externalities (positive & negative)
• Public goods (non‑excludable & non‑rival)
• Merit and demerit goods
• Imperfect competition (monopoly, oligopoly)
• Information asymmetry

2.5.1 Public Goods – Characteristics

• Non‑excludability: No one can be prevented from using the good.
• Non‑rivalry: One person’s use does not reduce the amount available for others.

2.5.2 Why the Market Misallocates Public Goods

• Firms cannot exclude non‑payers → free‑rider problem.
• Zero or negative profit expectation → no incentive to produce.
• Result: under‑provision or non‑provision of the good.

2.5.3 Implications of Misallocation (Non‑Provision)

1. Reduced social welfare: Potential benefits are lost, lowering total utility.
2. Equity concerns: Vulnerable groups (low‑income households, rural communities) miss out.
3. Negative externalities: Absence of the good can create harmful side‑effects (e.g., higher crime without policing).
4. Inefficient use of resources: Resources are diverted to private goods that do not meet collective needs.

2.5.4 Illustrative Table – Typical Market Outcome vs. Implication of Non‑Provision

2.5.5 Welfare‑Loss Illustration

The dead‑weight loss (DWL) from non‑provision is the area between the marginal social benefit (MSB) curve and the marginal cost (MC) curve up to the socially optimal quantity Q*:

\$\text{DWL} = \int_{0}^{Q^{*}} \big[ MSB(Q) - MC(Q) \big] \, dQ\$

2.5.6 Government Intervention to Correct Misallocation

• Direct provision: State builds & maintains roads, schools, hospitals, defence.
• Financing through taxation: Spreads cost across the whole population (benefits are non‑excludable).
• Subsidies & grants: Encourage private firms to produce quasi‑public goods (e.g., renewable energy).
• Regulation & standards: Mandate minimum provision (e.g., compulsory education, health‑safety standards).
• Nationalisation / privatisation: Transfer ownership to achieve socially optimal output.
• Quotas & price controls: Limit private provision when market outcomes are insufficient.

2.5.7 Evaluating Government Provision

• Fiscal burden: Higher taxes may reduce disposable income and private consumption.
• Efficiency issues: Public sector may lack profit motive → risk of over‑ or under‑supply.
• Political influences: Allocation can be swayed by lobbying or electoral considerations.
• Equity gains: Wider access to essential services for disadvantaged groups.

3. Micro‑economic Decision‑makers

3.1 Households

• Decision‑makers for consumption.
• Maximise utility subject to a budget constraint: Px·X + Py·Y ≤ Income.
• Preferences are represented by indifference curves; the highest attainable curve gives the optimal bundle.

3.2 Firms

• Decision‑makers for production.
• Goal: maximise profit = Total Revenue – Total Cost.
• Key cost concepts:

  • Total Cost (TC) = Fixed Cost (FC) + Variable Cost (VC)
  • Average Fixed Cost (AFC) = FC / Q
  • Average Variable Cost (AVC) = VC / Q
  • Average Total Cost (ATC) = TC / Q = AFC + AVC
  • Marginal Cost (MC) = ΔTC / ΔQ

• Short‑run vs. long‑run cost curves (U‑shaped MC, ATC; LRAC horizontal at minimum efficient scale).

3.2.1 Cost Diagram (Short‑run)

3.3 Labour Market

• Supply of labour: households offering work for wages.
• Demand for labour: firms’ marginal revenue product of labour (MRP_L).
• Equilibrium wage (W_e) and employment (L_e) where labour supply = labour demand.
• Wage determination affected by productivity, minimum wage legislation, trade unions.

3.3.1 Types of Unemployment (linked to macro‑section)

• Frictional – short‑term, job‑search.
• Structural – mismatch of skills/locations.
• Cyclical – caused by downturns in aggregate demand.
• Seasonal – predictable fluctuations (e.g., tourism).

3.4 Types of Markets & Firm Behaviour

• Perfect competition: Price taker, profit = 0 in long run (P = MC = ATC).
• Monopoly: Price maker, profit maximisation where MR = MC; P > MC → DWL.
• Monopolistic competition: Differentiated products, excess capacity (P > MC, ATC > MR).
• Oligopoly: Strategic interaction; possible collusion (cartels) or price wars.

3.5 Mergers & Economies of Scale

• Horizontal, vertical and conglomerate mergers aim to increase market power or achieve cost savings.
• Economies of scale: average cost falls as output rises (technical, managerial, financial).
• Diseconomies of scale can occur when a firm becomes too large (coordination problems).

3.6 Money & Banking

• Money functions: medium of exchange, store of value, unit of account.
• Banking system intermediates between savers and borrowers; creates money through the fractional‑reserve system.
• Interest rates influence investment and consumption decisions (the monetary transmission mechanism).

4. Government and the Macro‑economy

4.1 Macro‑economic Aims

• Economic growth (increase in real GDP).
• Low unemployment (close to the natural rate).
• Low and stable inflation (price stability).
• Balanced external accounts (current‑account equilibrium).

4.2 Fiscal Policy

• Government spending (G) and taxation (T) affect aggregate demand (AD).
• Budget deficit = G – T (when G > T); surplus when T > G.
• Multiplier effect: ΔY = k·ΔG (or ΔT) where k = 1/(1‑MPC).
• Expansionary fiscal policy – increase G or cut T to boost AD.
• Contractionary fiscal policy – decrease G or raise T to reduce AD.

4.3 Monetary Policy (Central Bank)

• Controls the money supply (M) and the policy interest rate.
• Tools: open‑market operations, reserve requirements, discount rate.
• Lower interest rates → cheaper borrowing → higher investment & consumption → AD rises.
• Higher rates → opposite effect.

4.4 Supply‑side Policies

• Improve productivity: training, research & development, infrastructure.
• Deregulation & reduction of red tape.
• Tax incentives for investment (e.g., capital allowances).
• Goal: shift the long‑run aggregate supply (LRAS) curve rightward, raising potential output.

4.5 Interaction of the Three Policy Tools

• Fiscal and monetary policy are often used together to stabilise the economy (counter‑cyclical policy).
• Supply‑side measures complement demand‑side policies by increasing the economy’s capacity.

4.6 Unemployment – Measurement & Types

• Unemployment rate = (Number of unemployed ÷ Labour force) × 100%.
• Seasonally adjusted rates remove regular seasonal effects.
• Structural, frictional, cyclical and seasonal unemployment defined in Section 3.4.

4.7 Inflation – Causes & Measurement

• Measured by the Consumer Price Index (CPI) or Retail Price Index (RPI).
• Demand‑pull inflation: AD > AS.
• Cost‑push inflation: rising production costs (e.g., wages, oil) shift AS left.
• Built‑in inflation: expectations of future price rises.

4.8 Public‑good Provision as a Stabiliser

• During a recession, government can increase spending on public goods (e.g., infrastructure) to boost AD.
• Such counter‑cyclical fiscal action helps maintain employment and long‑term growth.

5. Economic Development

5.1 Measuring Development

5.2 Poverty

• Absolute poverty: Living below a set minimum standard (e.g., $1.90 a day).
• Relative poverty: Living significantly below the average income of a society.
• Policies to reduce poverty:

  • Cash transfers (unconditional or conditional).
  • Micro‑credit and enterprise programmes.
  • Provision of public services (health, education, housing).

5.3 Factors Influencing Development

• Physical capital – infrastructure, machinery, transport.
• Human capital – education, health, skills.
• Technology & innovation – diffusion of new processes.
• Institutional quality – property rights, rule of law, political stability.
• Access to finance and markets.

5.4 Population Dynamics

• Growth rate = (Births – Deaths) + (Immigration – Emigration).
• Age‑structure diagram shows proportion of young, working‑age and elderly.
• Optimum population theory: a size where the marginal benefit of an additional person equals the marginal cost.

5.5 Comparison of Development Levels

5.6 Role of Public Goods in Development

• Infrastructure (roads, electricity) reduces production costs and attracts investment.
• Education and health services build human capital, raising productivity.
• Absence of these public goods hampers growth and widens inequality.

6. International Trade & Globalisation

6.1 Specialisation & Comparative Advantage

• Countries should specialise in goods with the lowest opportunity cost.
• Specialisation increases world output, allowing all trading partners to achieve higher welfare.

6.2 Free Trade vs. Protectionism

• Free trade: No barriers; goods move according to comparative advantage.
• Protectionist instruments:

  Instrument	Purpose	Potential downside
  Tariff	Protect domestic industry	Higher consumer prices; possible retaliation.
  Quota	Limit import quantity	Creates scarcity; may foster black markets.
  Subsidy	Encourage export or domestic production	Fiscal cost; market distortion.
  Import licence	Control volume of imports	Administrative burden; corruption risk.

6.3 Benefits and Costs of Trade

• Consumers gain from lower prices and greater variety (consumer surplus).
• Producers gain from larger markets (producer surplus).
• Terms of trade can improve for a country if export prices rise relative to import prices.
• Adjustment costs: structural unemployment, industry decline, income redistribution issues.

6.4 Globalisation – Causes & Consequences

• Causes: advances in transport & communications, liberalisation of trade and investment, multinational corporations (MNCs).
• Positive consequences: technology transfer, economies of scale, higher growth rates.
• Negative consequences: vulnerability to external shocks, environmental pressures, cultural homogenisation.

6.5 Foreign‑exchange Markets

• Definition: Market where currencies are bought and sold.
• Exchange rate regimes:

  • Floating – determined by market forces.
  • Fixed/pegged – set by government or central bank.

• Appreciation = domestic currency becomes stronger; depreciation = it becomes weaker.
• Determinants: interest‑rate differentials, inflation differentials, expectations, political stability.
• Effects:

  • Depreciation makes exports cheaper → can boost export‑led growth.
  • Appreciation makes imports cheaper → may increase import consumption but hurt domestic producers.

6.6 Balance of Payments – Current Account

• Current account = Trade balance (exports – imports) + Net income from abroad + Net current transfers.
• Surplus → net lender to the rest of the world; deficit → net borrower.
• Persistent deficits may lead to debt accumulation and exchange‑rate pressure.

7. Linking Misallocation of Resources to the Wider Economy

• Under‑provision of public goods reduces total social welfare, curbing long‑run economic growth (lower real GDP per capita).
• Equity problems from non‑provision exacerbate poverty and raise the Gini coefficient.
• Lack of infrastructure (roads, electricity, education) raises production costs for firms, reducing competitiveness in international markets.
• Government spending on essential public goods can act as a counter‑cyclical fiscal tool, stabilising output during recessions.
• Effective provision of public goods is a prerequisite for successful supply‑side policies and for attracting foreign direct investment.

8. Key Take‑aways

• Scarcity forces societies to choose; the PPC visualises efficient versus misallocated outcomes.
• The price mechanism usually allocates resources efficiently, but market failure—especially the non‑provision of public goods—creates misallocation.
• Public goods are non‑excludable and non‑rival, leading to free‑rider problems and under‑supply.
• Misallocation reduces social welfare, harms equity, and can generate negative externalities that affect the whole economy.
• Government intervention (taxation, direct provision, subsidies, regulation, nationalisation) aims to correct the failure, but must balance fiscal cost, efficiency, and political considerations.
• Understanding the interaction between micro‑decisions, macro‑policy, development, and international trade is essential for evaluating the broader impact of resource misallocation.