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Econ AS > 1.3 > Flashcards

1.3 Flashcards

1
Q

The main role of the price mechanism in a free-market economy

A

to allocate scarce resources efficiently.

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2
Q

Complete market failure happens when

A

market does not supply products at all

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3
Q

Partial market failure happens when

A

market functions, but it supplies either the wrong quantity of a product or at the wrong price

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4
Q

For markets to operate efficiently

A

property rights must be protected – perhaps through state regulation

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5
Q

Failure to protect property rights may lead to what is known as the Tragedy of the Commons

A

individuals with access to a public reserve (a common) act in their own self interest and thus ultimately deplete the resource

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6
Q

Externalities are defined as

A

spill-over effects from production and/or consumption to third parties

  • can be negative or positive
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7
Q

Externalities cause market failure if

A

The price mechanism does not take account of the social costs and benefits of production and consumption

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8
Q

Private costs are the costs faced by

A

producer or consumer directly involved in a transaction.

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9
Q

When negative externalities exist when social costs exceed

A

Private cost

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10
Q

External costs occur when the activity of one agent has a

A

Negative effect on the well-being of a third party

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11
Q

key aspect of all externalities is the difficulty of assigning values:

A
  1. Shadow pricing: monetary value assigned to an abstract or intangible commodity which is not traded in the marketplace e.g. the external cost of road congestion can be calculated by multiplying the number of hours lost by the average wage e.g. 1m lost working hours x £12 average hourly wage = £12m
  2. Compensation estimate the cost of correcting an externality e.g. includes the cost of installing double-glazing in houses affected by increased road noise from a new motorway. If 200 houses are affected each with £5,000 double glazing cost, increased road noise is estimated at £1m
  3. Revealed preference- how much people are willing to pay to avoid an externality
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12
Q

Marginal private cost (MPC)

A

o Cost to the producing firm of producing an additional unit of output or costs to an individual of any economic action. Private costs are internal costs.

demand curve represents private benefits, supply curve represents private costs

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13
Q

Marginal external cost (MEC)

A

Cost to third parties from the production/consumption of an additional unit of output

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14
Q

Marginal social cost (MSC)

A
  • total cost to society of producing an extra unit of output

- MSC = MPC + MEC

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15
Q

Marginal external benefit (MEB)

A

o The benefit to a third party from the production/consumption of an additional unit of something

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16
Q

Marginal social benefit (MSB)

A

o Total benefit to society from consuming an extra unit.

o MSB = MPB + Marginal External Benefit (MEB)

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17
Q

Examples of negative externalities from production

A
  • air pollution from factories
  • pollution from fertilisers
  • industrial waste
  • noise pollution
  • collapsing fish stocks
  • methane emissions
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18
Q

If MSC pivots away from MPC, then

A

Marginal external cost of extra output is increasing

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19
Q

When equilibrium is at MSC

A

price goes up as market has recognised and accommodated for negative externalities such as pollution

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20
Q

social welfare loss is when market output (q1)

A

is higher than the optimum social position (q2)

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21
Q

Negative externalities from consumption

A
  • noise pollution from neighbours
  • air pollution from smokers
  • vehicle pollution
  • litter from tourists
  • spillover costs from rising levels of obesity
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22
Q

Positive externalities exist when third parties

A

benefit from the spill-over effects of production/consumption e.g. the social returns from investment in training or the positive benefits from health care/medical research.

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23
Q

Social benefit =

A

private benefits plus external benefits

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24
Q

If there are negative externalities, then we must add the external costs to the firm’s

A

supply curve to find the marginal social cost curve (MSC).

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25
Q

If there are positive externalities, then we must add the external benefits to the demand curve

A

demand curve (i.e. the marginal private benefit (MPB) curve) to find the marginal social benefit curve (MSB).

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26
Q

if market ignores positive externalities,

A

then there’ll be underconsumption, leading to a misallocation of resources

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27
Q

Marginal private benefit (MPB):

A

benefit to the consumer of consuming an additional unit of output

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28
Q

Marginal external benefit (MEB)

A

benefit to third parties from the consumption of an additional unit of output

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29
Q

Marginal social benefit (MSB)

A

total benefit to society of consuming an extra unit of output. MSB = MPB + MEB

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30
Q

With positive (consumption) externalities, marginal social benefit is

A

higher than marginal private benefit

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31
Q

Examples of positive consumption externalities

A
  • health programmes
  • bike schemes
  • free school meals
32
Q

social optimum is where msb =

A

msc

33
Q

negative externalities means MSC has

A

a higher gradient than MPC

34
Q

A private good or service has three main characteristics:

A

Excludable
Rival in consumption
Rejectable

35
Q

excludable?

A

excludability gives seller the chance to make a profit, buyers can be excluded if they are not willing and able to pay for it

36
Q

Non rivalrous?

A

One person’s use of a good does not prevent others from being unable to benefit and consume the good

37
Q

rejectable?

A

The consumer can reject private goods and services if their needs and preferences or their budget changes.

38
Q

What are the key features of pure public goods?

A
  • non excludability - (could cause a free rider problem)
  • non-rivalrous
  • non rejectable (eg, nuclear defence system)
39
Q

It is up to the government to decide what, and how?

A

output of public goods is appropriate for society.

Estimate the net social benefits from making public goods available.

40
Q

do governments have to provide public goods?

A

NO, They might finance them but leave delivery to the private sector.

41
Q

Pure public goods are not normally provided by the private sector because

A

free rider problem, so no revenue for firms

42
Q

A quasi-public good is a

A

near-public good

43
Q

features of quasi public goods

A
  • Semi-non-rival, ie it is public up to a point

- Semi-non-excludable, ie it is possible but difficult or costly to exclude non-paying consumers

44
Q

The Free-Rider Problem

A

The free rider problem leads to non-provision of a pure public good and thus causes pure market failure.

45
Q

For markets to work, there needs to be symmetric information

A

i.e. consumers & producers have the same knowledge about products, they know everything there is to know about the effects of consuming them

46
Q

Asymmetric information is when information does exist but

A

there is an imbalance in information between buyer and seller which can distort their choices

47
Q

chain of reasoning if car sellers know more than buyers

A
  • sellers know more about quality
  • buyers can’t tell quality
  • buyers will offer average price for all cars
  • typically lower than sellers perceived value
  • sellers may remove good vehicles from sale
  • average quality of cars drop
  • buyers no longer buy at previous prices = higher risk of market disappearing
48
Q

Moral hazard occurs when

A

insured consumers are likely to take greater risks, knowing that a claim will be paid for by their cover.

49
Q

if consumers had better/fuller information on the benefits to themselves of consuming a good

A

marginalprivate benefit curve would shift lower leading to a smaller equilibrium quantity.
= possible market failure

50
Q

screening

A

finding out as much as possible about another agent in a transaction

51
Q

three main types of market failure:

A
  • externalities
  • under-provision of public goods
  • information gaps
52
Q

externalities

A

an externality is the cost or benefit a third party receives from an economic transaction outside of the market mechanism. (define) spill over leads to over/under production of goods, meaning resources aren’t allocated efficiently

53
Q

under provision of public goods

A

public goods are non-rivalry and non-excludable, meaning they are underprovided by the private sector due to the free rider problem.
market is unable to ensure enough of these goods are provided, eg streetlights

54
Q

information gaps

A

homo economicus assumed to have perfect info, just like firms, so are assumed to make completely rational decisions. BUT, agents do not always make rational decisions and so resources are not allocated to maximise welfare. eg, 2nd hand goods

55
Q

when there are asymmetric markets

A

government provides information to allow people to make informed decisons, like smoking and drinking

56
Q

a merit good is

A

a good with external benefits, where the benefit to society is greater than the benefit to the individual, tend to be underprovided by the free market

57
Q

a demerit good is

A

good with external costs, where the cost to society is greater than the cost to the individual, tend to be overprovided by free market

58
Q

negative externalities of production occur when

A

social costs are greater than private costs

59
Q

economy should produce at

A

MSB=MSC, the social optimum position at Q2P2,

difference between MSC and MPC increases at output grows, because external costs grow the more that people do something (think driving)

60
Q

positive externalities of consumption occur when

A

when social benefits are greater than social costs

61
Q

if market considers all benefits

A

will produce at MSB=MSC at Q2P2, failure of market to consider external benefits has led to the misallocation of resources so there is an underproduction of Q1-Q2, leads to a welfare loss in the shaded area. gap grows as output grows, eg vaccination

62
Q

difficult to work out size of

A

externality as it tends to be placed on value judgements, since it is difficult to monetise external costs, lots of externalities involved with information gaps, as people are unaware of full implications of their decisions

63
Q

government intervention

A 
indirect taxes and subsidies
tradable pollution permits
provision of the good
provision of information
regulation
64
Q

indirect taxes and subsidies

A
  • taxes can be put on goods with negative externalities and subsidies on goods with positive externalities
65
Q

tradable pollution permits

A

these allow firms to produce up to a certain amount of pollution, and can be traded amongst firms to give them a choice whilst reducing level of pollution

66
Q

provision of the good

A

when social benefit is very high, gov may decide to provide the good through taxation, eg, healthcare/education

67
Q

provision of information

A

since some externalities are associated with information gaps, gov can provide info to help people make informed decisions and acknowledge external costs

68
Q

regulation

A

this could limit consumption of goods with negative externalities, eg banning smoking ads

69
Q

public goods are non-rivalry + non-excludable

A

NR - which means that one persons use of the good doesn’t stop someone else from using
NE - meaning you can’t stop someone from accessing the good and someone can not choose to not access the good

eg, streetlights, roads are quasi

70
Q

free rider problem

A
  • can’t charge an individual a price for the provision of a non-excludable good because someone else will gain the benefit from it without paying anything
  • private sector producers will not provide public good to people because the cannot be sure of making profit, due to non-excludability of public goods, therefore if proven was left to market mechanism, market would fail
71
Q

what is a free rider

A

someone that receives the benefits without paying forr them

72
Q

symmetric information

A

when buyers and sellers have potential access to same info, but many decisions are based on imperfect info and so economic agents are unable to make informed decisions (suffer from information gaps)

73
Q

asymmetric information

A

when one party has superior knowledge compared to another. usually, the seller has more info than the buyer and this means they can take advantage of the other parts lack of knowledge, by charging them a higher price

74
Q

problems with advertising

A

leads to info gaps because it is designed to change attitudes of the consumers to encourage them to buy the good, could cause them to think benefits are greater than they are
- improvements in technology mean info gap are on the decline

75
Q

info gaps lead to

A

market failure as there is a misallocation of resources, because people do not buy things that maximise their welfare
- means consumer demand/ prod supply too high/low so price and quantity not at social optimum position

76
Q

examples of information gaps

A

drugs, pension, financial services

Econ AS (16 decks)

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