Market Failure Climate Change

Economists and experts alike argue that climate change is the greatest market failure. This is majorly due to the businesses’ inability to account for the costs of their emissions, which impact society negatively. But how did climate change become a market failure and what are its consequences if left unchecked?

Market Failure Climate Change Market Failure Climate Change

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Table of contents

    Climate change as a market failure

    A market failure causes an inefficient distribution of products and services in a free market. It affects the intended outcomes expected by the market and environmental players.

    Market failure is a situation in which transactions involving some products in a free market are inefficient. Here, the benefits and costs of the transaction are not limited to the supplier and consumer but spill over to third parties. This spillover leads to an inefficient distribution of resources.

    An example is the gas pollution emitted from industrial processes. The individual consumer or producers don’t feel the cost of this pollution but society does. Thus, we say market failure occurs when free-market processes affect societal welfare.

    Climate change is the significant changes in weather patterns over a period. A major cause of climate change is the emission of greenhouse gases from various market processes involving the burning of fossil fuels.

    Economists believe that climate change is the greatest market failure because it’s the product of multiple market failures that organisations have been unable to account for. The biggest one is the social and environmental cost of releasing greenhouse gases, like carbon dioxide and chlorofluorocarbons that travels to the earth's atmosphere, absorb, and trap heat.

    Check out our explanation about Market Failure to learn more about this topic.

    Market Failure Climate Change An industrial site releasing gases StudySmarterA factory releases greenhouse gases into the atmosphere, Pixabay.

    Is climate change caused by many market failures?

    Climate change is a market failure. Economists like Nicholas Stern have shown that climate change is the result of many other market failures.

    One of these market failures is the greenhouse - gas externality. Due to our economic activities, we release many greenhouse gases like CO2 (carbon dioxide), CH4 (methane), and N2O (nitrous oxide), into our atmosphere. The emission of these gases doesn’t affect the firms that produce them, but they have a negative effect on society. These societal effects of greenhouse gases are called negative externalities.

    Externalities occur when organisations make decisions that only consider their costs and profit, but not the effects of producing their goods and services on society.

    When a business doesn’t consider the effect of its activities on society, society has to bear the cost of the business emissions. You can see this in Figure 1.

    Market Failure and Climate Chnage Negative externalities StudySmarter OriginalsFigure 1. Negative externalities, StudySmarter Originals

    In Figure 1 above, we can see that the social costs are greater than the private costs. This is true because when a firm produces a good or service that emits greenhouse gases, the social costs to the environment and third parties is greater than the production costs.

    Causes and consequences of climate change

    Due to a constant drive towards innovation and beating their competition, organisations look for ways to make production processes easier and provide unique products to consumers. This innovative evolution has led them to burn fossil fuels during their production processes. In turn, it has also led consumers to contaminate the environment when consuming certain products. The gases released during the burning of these fossil fuels are mostly greenhouse gases which lead to climate change.

    Climate change is caused by multiple market failures:

    • A market failure due to the little information on the reduction of greenhouse gas emissions.

    • Network effects.

    • Little or no incentive for innovation on low-carbon products.

    The consequences of climate change as market failure are hard to predict over the long term. We can predict, however, that climate change will be mostly experienced by underdeveloped nations and future generations.

    These consequences include:

    • Thinning of the ozone layer. This causes more heat rays to reach the earth.

    • More severe storms.

    • Increased sea levels.

    • Droughts and health challenges.

    One solution that economists have suggested is government intervention by introducing policies that increase the cost of the processes that release greenhouse gases into the environment.

    In a move to avoid biases, the cost of carbon release during industrial or household processes should be uniform. This can be achieved through the introduction of carbon emission taxes or emissions trading schemes.1

    Also, governments should stimulate a drive towards low-carbon releasing innovations such as the production of electric vehicles. This can be achieved by providing subsidies and incentives to bodies that are investing in these innovations.

    Policy and government support should aim towards the generation of new networks. An example of this is the creation of smart electric grids for electric cars and charging spots to promote the usage and development of these technologies.

    Businesses should also adopt the green energy approach. This involves the use of renewable energy sources and green-certified materials for their production processes.

    Green certification are used to indicate environmentally friendly products or processes.

    In conclusion, though the consequences of climate change as market failure are hard to predict over the long term, the negative externalities it currently has on the immediate environment are hard to ignore. Governments need to put regulations in place to check businesses activities that have a direct impact on society and to safeguard the environment.

    Market Failure Climate Change - Key takeaways

    • Market failure occurs when transactions in a market are inefficient. The benefits and costs of the transaction are not limited to the suppliers and consumers only, but spill over to third parties.
    • Climate change is the significant changes in weather patterns over a period. A major cause of climate change is the emission of greenhouse gases from various market processes involving the burning of fossil fuels.

    • Though greenhouse gases emissions are by-products of economic development activities, the emissions of these gases doesn’t affect the organisations producing them, but has a negative effect on society as a whole. These societal effects of the greenhouse gases are called negative externalities.
    • The multiple market failures that lead to climate change are:
      • Market failure due to little information on reduction of greenhouse gas emissions.

      • Network effects.
      • Little or no incentive on innovation of low-carbon products.

    Sources

    1. Clara Changxin Fang. Sustainability (Aug 2018) https://www.liebertpub.com/doi/full/10.1089/sus.2018.0011

    What are externalities?

    Externalities occur when organisations make decisions that only consider their costs and profit, but not the effects of producing their goods and services on society.

    Market Failure Climate Change Market Failure Climate Change
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    Frequently Asked Questions about Market Failure Climate Change

    Why do economists describe climate change as a market failure?

    Economists describe climate change as a market failure due to the inability of organisations to account for the release of greenhouse gases into the atmosphere during production and consumption processes.

    Is climate change a market failure or a government failure?

    Climate change is a market failure.

    Is climate change the biggest market failure?

    Climate change is argued by many economists to be the biggest market failure.

    What is market failure in climate change?

     Market failure in climate change is the negative effects of market processes on climate change.

    What are the impacts of climate change as a market failure?

    The impact of climate change as market failure is hard to predict in the long term. It will be mostly experienced by underdeveloped nations and future generations. 


    These impacts include: 

    • Thinning of the ozone layer that causes more heat rays to reach the earth.

    • More severe storms.

    • Increased sea levels. 

    • Droughts and health challenges. 

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