1.3/4: market failure/gov. intervention Flashcards
What us allocative efficiency
When no one can be made better off w/o making someone else worse off (pareto efficiency)
On PPF Curve
What is the indicator of allocative efficiency
market price = marginal cost of supply
What is productive efficiency
when producers minimise wastage of resources; implies best use of factor inputs of production
What is indicative of a productively efficient economy
It is operating at the lowest point on its AC curve
What is dynamic efficiency
concerned with the productive efficiency of a firm over a period of time.
A firm which is dynamically efficient will be reducing its cost curves by implementing new production processes → a reduction in both SRAC and LRAC
What is an X-Inefficiency and draw the graph
When a business uses more inputs than are necessary for a given level of output
What tyically causes an X-Inefficiency ( according Libenstein)
A lack of effective competition in a market allows companies to let their fixed costs of production to rise
What are merit goods
goods which consumers may undervalue but the government believes are ‘good’ for consumers
so would be underprovided in the market
What are demerit goods
goods which are deemed to be socially undesirable and are like to be overconsumed/produced in a free market
e.g. cigarettes, alcohol
What is socially efficient
When marginal social benefit = marginal social cost
Why does the market not provide the social optimum
Ass it doesnt take into account the social costs and benefits all the time
What is market failure
where resources are inefficiently allocated due to imperfections of the market mechanism
What are the 2 forms of market failure and define them
Partial market failure - over/under production of goods
Complete market failure - markets may not exist
What are the 3 types of market failure
- Externalities
- Underprovision of public goods
- Information gaps (assymetric information)
What are externalities
External costs and benefits not accounted for in the private costs and benefits
What is a private cost
cost of an activity to an individual economic unit
What is a social cost
cost of an acitivty to the whole of society; private + external
What is a negtaive externality of production
When social costs are greater than private costs
What is a positive externality of consumption
when social benefits are greater than private benefits
What is a consumption externality
when the social and private benefits differ
What is an externality of consumption
when the social benefits of consumption differ from the private benefits of consumption
What is a production externality
when the social costs of production are different from the private costs of production
At what point is welfare maximised
(private) marginal costs= (private) marginal benefit
Draw a negative production externality diagram and describe the steps
- axis of price and output
- Draw msb=Mpb downward sloping curve
- Draw MSC and MPC; MSC>MPC (MSC inward shift)
- Mark on market optimum (PB=PC) and social optimum (SC=SB)
- From market optimum upwards, draw a dotted line to MSC line
- draw this triangle and label it as the welfare loss
Draw a positive externality of consumption diagram
- Draw axis; price and output
- Draw MSC=MPC upwards sloping curve
- Draw MSB and MPB lines (downwards) separately with MSB>MPB (MSB outward shift)
- Mark on the market + social optimum
- (Again) draw a dotted line upwards from the market optimum to the MSB
- Shade in the triangle and label it potential welfare gain
What are the 2 qualities of a private good
-
rivalrous - consumption by one person results in the good not being avaliable for consumption by another peson
- excludable - once provided, it is possible to prevent other from using it
What are some examples of a negative externality of production
air pollution from factories, industrial waste, methane emissions
What are some positive externality of consumption examples
having a healthy diet, education, exercising
What are the 3 characterisitcs of a (pure) public good
non-rivalry = consumption of the good by one person does not reduce the amount avaliable for consumption by another person (non-diminishability)
non-excludability = once provided, no person can be excluded from benefitting and no person can opt out from recieving the good (non-rejectablity)
marginal cost is 0
What are some examples of public goods
- judiciary/prison service
- police service
- street lighting
What is the free rider problem
Impossible to prevent people from benefitting → little incentive to pay for the consumption of a public good → underprovided in a free market
What is the solution to the free rider problem
State to provide public goods and force everyone to contribute through taxation
or
quasi public good
What is a quasi-public good
Semi-non rival : up to a point, more people using a park, beach or road does not reduce space for others
Semi-non-excludable: difficult/costly to exclude non-paying customers
What are some examples of quasi public goods
TV licenses, ships pay ‘light charge’ for lighthouses,
What are the advantages of government provision
- It is equitable that all can access it, free of charge
- Helps reduce/solve the market failure, especially when markets are missing either completely (public goods) or partially (+ext)
- Increase production and consumption of public and merit goods to the social optimum helping to equate MSC=MSB at the social optimum P=MC
What is a global public good
A good that benefits every company
e.g. security from war, law, eradication of diseases, proliferation of nuclear weapons, agreements towards protection of ozone layer
What is a public bad
a “bad” that is non-excludable and nondepletable
e.g. air pollution
What is information failure
when people have inaccurate or incomplete data and so make potentially ‘wrong’ choices
What is assumed in competitive markets
that there is perfect information
What are the causes of information failure
- Long-term consequences: Information gaps about long term benefits
- Complexity
- Assymetric information
- Price information: unable to quickly / cheaply find sufficient information on the best prices for different products
Show the market failure of an information gap that would benefit them (in terms of price) on a graph
the the marginal private benefit curve would shift outwards leading to a higher equilibrium quantity
What are some examples of information failure
- Complexity of pension schemes
- Uncertain quality of second hand products
- Tourist Bazaars or buying and selling antiques
What is assymetric information
there is an imbalance in information between buyer and seller which can distort choices
What is an example of assymetric information
- Insider information of traders in financial market
- Information advantages for high-frequency stock market traders
- Second hand cars
What are the 2 aspects of assymetric information in the insurance market
Moral Hazard + Adverse Selection
What is Moral Hazard
insured consumers are likely to take greater risks, knowing that a claim will be paid for by their cover
What is adverse selection
most likely to claim buy insurance and insurer knows this and so raises the average price of insurance cover
How do they adress policies for information failure
Government action can improve information to help consumers and producers value the actual cost and/or benefit of a good or service.
What is an ad valorem tax
percentage tax e.g. 20% on the unit price
specific tax
set tax per unit
What is the effect of an ad valorem tax on a supply curve
to cause a pivotal shift in the supply curve
If PED>1 and indirect tax who will absorb most of the costs.
if the co-efficient of price elasticity of demand >1, then most of the burden of an indirect tax will be absorbed by the supplier
indirect tax & PED<1 who will absorb most costs
If the co-efficient of price elasticity of demand <1, most of an indirect tax can be passed on to the final consumer
What does a government subsidy do to the supply curve ( Draw graph and show subsidy)
Causing an outward shift
How do you calculate government spending on the subsidy.
Both formula and shading on a graph
Total spending = government susbsidy per unit * quantity produced
If the market PED is elastic, what is the stronger effect of a subsidy
It has a strong effect on the quantity
If the PED is inelastic what is the larger effect of the subsidy
it has a larger effect on the new price
What is cost benefit analysis
Process used to measure the estimated net social rate of return from an investment
Problems with cost benefit analysis
- hard to assign monetary values e.g. water/air quality, social inclusion
- Uncertainty with major products e.g. population growth, operating costs
What is the economic incidence of a subsidy
Indicates who is made better off by the subsidy
What is the legal incidence of the subsidy
indicates who, by law, the subsidy is intended to help
Why does the price of a good not fall by the full effect of the subsidy
The producer keeps the extra revenue
What is the overall cost of the subsidy to the government in this graph
CABP1
What is the gain to the consumer, the total gain and the extra they pay after the subsidy
the gain is P-P1 per unit and the whole gain to the consumer if PFB1
the extra bit they pay is LFQQ1
Mark on the sections where there is benefit to the producer and benefit to consumer as a result of the subsidy
Where is the producer revenue on this graph of indirect taxation
where is the welfare loss on this indirect tax
What are the disadvantages of government provision
- Excess demand due to inadequate provision and no price mechanism allocating resources.
- Private provision may be better as there is a profit motive. This results in improved service/quality.
- Govt=diseconomies of scale and X inefficiency (costs higher than they should be)
Define a minimum price
the lowest price that can legally be set / the price floor
Define a maximum price
highest price that can be set by a producer
Define excess demand
situation in which the demand for a product or service exceeds its supply in a market
Define excess supply
quantity of a good or service supplied is more than the quantity demanded
Define government failure
an economic inefficiency caused by a government intervention
Government intervention
any action carried out by the government or public entity that affects the market economy with the direct objective of having an impact in the economy,
define a subsidy
a government grant given to firms to boost production
