CHAPTER 7 - Potential Market Failures

Abstract

This chapter discusses several potential sources of externalities and market failure in relation to population size and intergenerational allocation of resources. After scrutiny, some of these potential sources of market failure prove to be nonexistent. The chapter focuses on three potential causes of market failure. The first source is that if there are pure public goods such as national defense, basic research, and weather forecasts, the per capita costs of providing these goods fall as population size increases. As everyone enjoys these goods at no additional cost, it is possible that there exists a market failure in relation to population size resulting in the inefficiency of laissez-faire. The second source is that a fixed resource, such as land, which must be combined with labor to produce goods for consumption, could lead to Malthusian diminishing returns to larger population size. This situation suggests a potential source of external diseconomies and market failure in relation to population size. the third source is that there is the problem associated with the infinity of generations in an overlapping generation model. In his seminal paper, Samuelson showed that even without the standard sources of market failure, the competitive equilibrium may fail to achieve Pareto efficiency. When fertility is endogenous, these potential sources of market failure do not exist: laissez-faire policy leads individual decision makers to a Pareto-optimal allocation from their point of view.