05 Market Failure: The 6 Market Failures - monopolies, externalities, merit and de-merit goods Flashcards
Define barriers to entry (B2E).
Factors that prevent firms from entering a market profitably.
What is the B2E acronym?
LTSB
- Legal
- Technical
- Strategic
- Brand Loyalty
What are the legal barriers to entry, for a new firm?
1 - Patents - sole ownership
2- Licences/permits - expensive, and difficult to obtain
3 - Red Tape - excessive paper work
4 - Standards and regulations - health and safety, environmental, pollution, minimum wages
5 - Insurance
What are the technical barriers to entry, for a new firm?
- High start up costs
- Sunk costs - can’t be recovered when a firm leaves the market - e.g., advertising, specialist machinery
- Economies of scale - firm growth leads to lower average costs - difficult for new firms to enter the market
- Natural monopoly - new firm driven out very easily
What are the strategic barriers to entry, for a new firm?
1 - Predatory pricing - pricing lower on purpose to drive out competition
2 - Limit pricing
3 - Heavy advertising
What are the economic benefits of monopoly power?
- Research and development and dynamic efficiency
- Economies of Scale - firms could charge a lower price
- International competition - imports and exports
- Regulation (competition and markets) - can’t always make decisions that will not benefit the consumer
Define Private Costs.
A direct cost to a producer or consumer - these costs are taken into account by the price mechanism.
Define Private Benefits.
A direct benefit to a producer or consumer - these benefits are taken into account by the price mechanism.
When consumers, firms and government (or economic agents) make decisions they will consider…
the private costs and benefits.
The free market equilibrium is where…
Private costs = private benefits
Define external costs.
AKA negative externalities - negative effects on third-parties (not the producer or consumer) - ignored by the price mechanism.
Define external benefits.
AKA positive externalities - positive effects on third-parties (not the producer or consumer) - ignored by the price mechanism.
A smoker may ignore external costs, such as…
- The impact of those around them in terms of health
- Risk of fire
- A rise in taxes to fund the NHS due to more cancer patients
The private healthcare patient may ignore the external benefits, such as…
- Increasing life expectancy and therefore working longer
- Less strain on the NHS
- Productivity gains
- More enterprise out of a more wealthy population
Define social costs.
Private cost + external cost
Define social benefits.
Private benefit + external benefit
What are the private costs and benefits of higher education?
PC = cost of degree - £9,000 per annum, opportunity cost (of working) PB = increased future income, making friends
What are the external costs and benefits of higher education?
EC = some people can't afford it EB = more skill and flexible workforce
Why is higher education a market failure?
In a free market, higher education would be under consumed.
What are the private costs and benefits of cigarette consumption?
PC = Lung cancer PB = Pleasurable
What are the external costs and benefits of cigarette consumption?
EC = Passive smoking, high healthcare costs, fall in productivity and size of the workforce
Why is cigarette consumption a market fialure?
Over-consumed in a free market - it’s a de-merit good. Taxes not high due to not much government intervention.
Define diminishing marginal utility?
If the consumption of a good or service increases, the satisfaction derived gradually increases but at a decreasing rate, to the point where it reaches zero. Total satisfaction is maximised when marginal utility is zero.
On a diagram marginal private benefit is…
downward slopping - the more extra units consumed, the lower the benefit.
On a diagram marginal private costs is…
upward slopping - the more extra units that are produced, the higher the cost.
Free market equilibrium is where…
MPC = MPB
The free market is when (in diagram terms)…
when MPC = MPB
The socially optimum market is where (on a diagram)…
MSC = MSB - no production externality
The weight loss triangle will always point to the…
socially optimum equilibrium
The socially optimum equilibrium can be defined as…
where society (and economists) want the market equilibrium to be.
Define welfare loss.
The excess of social cost above social benefit for a given quantity (social cost > social benefit).
Define welfare gain.
Social benefit > Social cost.
Production externalities relate to a divergence between…
the MPC and the MSC.
Consumption externalities relate to a divergence between…
the MPB and MSB.
Define the Tragedy of the Commons.
Where a lack of property rights (ownership) leads to negative productive externalities - governments do not own areas, such as sea, forests, etc. Therefore, there could be a misallocation of resources due to no regulation - over exploited resources - is a an environmental market failure.
One of reasons for environmental market failure is…
lack of clearly defined property rights relating to environmental resources such as the oceans, forests or atmosphere.
As a result of a lack of clearly defined property rights, firms or consumers don’t…
suffer any penalty for polluting the atmosphere, dumping waste in the oceans, or excessive deforestation - leads to overuse of these resources and the rapid depletion of non-renewable resources.
Define merit goods.
Goods that are under-consumed in the free market and release positive consumption externalities.
Define de-merit goods.
Goods that are over-consumed in the free market and release negative consumption externalities.
Who provides merit goods?
Both the state and private sector.
Why are merit goods under-consumed in a free market?
Imperfect information:
- People are not aware of the potential private benefits to themselves from consumption, especially in the long term
- People may not be able to afford the product
- People may not take into account the external benefits to society
Why are de-merit goods over-consumed in a free market?
Imperfect information:
- People unaware of damage to their health arising from consumption
- Goods are too cheap and so people can too easily afford them, or they are too accessible
- Individuals do not take account of the wider external costs associated with their consumption
What are examples of merit goods?
- Health care
- Education
- Exercise
What are examples of de-merit goods?
- Cigarettes
- Alcohol
- Gambling
Note that not all products that result in positive or negative externalities in consumption are…
either merit or de-merit goods.
