1.3 Market Failure Flashcards
1
Q
market failure
A
- when the free market fails to allocate scarce resources efficiently, causing a loss in social welfare
- there’s either under or over-provision of the good/service, so resources aren’t allocated efficiently
- can be positive (e.g. education) or negative (e.g. cigarettes) and on production or consumption
2
Q
types of market failure - externalities
A
- a cost/benefit to a third party not involved in the economic transaction (spillover effect)
- it leads to over/under production of goods, so resources aren’t allocated efficiently
3
Q
types of market failure - under-provision of public goods
A
- public goods are non-excludable and non-rival, so they’re under-provided by the free market due to the free-rider problem
- i.e. less opportunity for sellers to make economic profits from providing public goods
- e.g. streetlights
4
Q
types of market failure - information gaps
A
- information gaps distort market outcomes, resulting in market failure
- can occur due to imperfect knowledge (lack of knowledge) or asymmetric info (when one party has more info than the other)
5
Q
externalities
A
- an external impact (cost or benefit) on a third party not involved in the economic transaction;
- positive externality of consumption; consumption of electric vehicles reduce C02 emissions
- positive externality of production; the construction / operation of an airport will benefit local businesses because of the increased accessibility
- negative externality of consumption; consumption of alcohol increases antisocial behaviour
- negative externality of production; production of electricity increases air pollution
6
Q
private, external, and social costs
A
- private cost; cost to the individual, i.e. what the producer pays to sell and what the consumer pays to buy a good/service
- external cost (negative externality); the costs to a third party not involved in the economic activity
- social cost; full costs to society, i.e. private + external costs
7
Q
private, external, and social benefits
A
- private benefit; benefit to the individual, i.e. revenue gained for the producer and the satisfaction of consumption for the consumer
- external benefit (positive externality); the benefits to a third party not involved in the economic transaction
- social cost; full benefits to society, i.e. private + external benefits
8
Q
externalities diagrams
A
- shows MPB and MSB (benefit to individual and society of an extra unit consumed) on the demand curve
- shows MPC and MSC (cost to individual and society of an extra unit consumed) on the supply curve
- production externality; 2 supply curves
- consumption externality; 2 demand curves
- positive externality; shift outwards (right)
- negative externality; shift inwards (left)
- welfare gain; above supply curve
- welfare loss; above demand curve
- free market equilibrium; MPB = MPC
- social optimum level; MSB = MSC
9
Q
negative production externality
A
- diagram 1
- supply shifts inwards to reduce welfare loss
- market is failing due to over-provision of the (demerit) good/service as the producers only consider private costs
- if external costs were considered, output would decrease to the social optimum level and price would rise
- e.g. noise pollution from airplanes, external costs of fertilisers and pesticides used in farming (e.g. soil contamination), etc.
10
Q
positive consumption externality
A
- diagram 2
- demand shifts outwards to increase welfare gain
- market is failing due to under-provision of the (merit) good/service as the consumers only consider private benefits
- if external benefits were considered, output would increase to the social optimum level and price would rise
- e.g. healthcare, education, etc.
11
Q
govt. intervention with externalities
A
- indirect taxes and subsidies; taxes can be put on goods with negative externalities and subsidies on goods with positive externalities, to help internalise the externalities, moving production closer to the social optimum level
- tradeable pollution permits; imposed on firms with negative externalities to limit their production of pollution
- provision of the good; when social benefits are very high, the govt. may provide the good through taxation, e.g. with education and healthcare
- provision of information; the govt. can help provide info to reduce information gaps, which are associated with some externalities, as it can help people acknowledge external costs
- regulation; this can limit consumption of goods with negative externalities, e.g. banning advertising of smoking
- however, it’s hard to quantify the externality and identify the social optimal level, so the govt. regulation may be ineffective if they under-estimate it
12
Q
impact of negative externalities on economic agents
A
- obesity; increased costs for NHS - £6billion a year
- alcohol; increased costs for NHS, as well as the police and council (due to the behaviour of drunkards - higher crime)
- smoking; increased costs for NHS, and increased air pollution
13
Q
impact of positive externalities on economic agents
A
- education; higher skills means people have better jobs so they bring greater economic value to their community; e.g. higher skills means more doctors, which help many
- healthcare; private treatment, e.g. vaccinations, help many others as it prevents spread of the disease
- public transport; e.g. taking a train reduces congestion for other travellers (more space on roads)
14
Q
public goods
A
- goods that are beneficial to society but won’t be provided by the free market, as they’re;
- non-excludable; consumers can’t be excluded from using the product
- non-rivalry; one person’s use of the good doesn’t stop someone else from using it
- so, the govt. will often provide these beneficial goods themselves
- e.g. street lights
15
Q
quasi public goods
A
- goods which are semi non-excludable (it’s hard but possible to exclude customers) and semi non-rival (up to a certain point, consumption of the good doesn’t limit availability for another person)
- e.g. roads - semi-excludable due to tolls, and semi-rivalry as congestion causes issues
16
Q
private goods
A
- goods sold through the private sector, which are;
- excludable; anyone who can’t purchase goods is excluded from consumption
- rivalry; consumption by an individual prevents other individuals consuming the same good)
- most goods are private goods
- e.g. mobile phones
17
Q
free rider problem
A
- since public goods are non-excludable, you can’t charge an individual for the provision of the good, as someone else will gain the benefit from it without paying anything
- a free rider is someone who receives the benefits without paying for it
- this causes under-provision in a free market as private sector firms won’t provide public goods since they won’t make a profit, and this causes market failure so public goods are provided by the govt. and financed through taxation
18
Q
information gaps - symmetric and asymmetric information
A
- info gaps occur when people have inaccurate / incomplete data needed to make an informed decision
- advertising leads to info gaps as it can change attitudes of consumers to encourage them to buy the good
- increases in technology can decrease info gaps as people can get more info
- e.g;
- drugs, where users don’t see the long-term issues
- nutritional content in food
- pensions, where young people don’t see the long-term benefits of paying into pension schemes
19
Q
symmetric and asymmetric information
A
- symmetric info occurs when buyers and sellers have access to the same info
- asymmetric info is when one party has superior knowledge compared to the other
- usually the seller has more info than the buyer, so they can exploit their lack of knowledge by charging a higher price, e.g. in the used car market, sellers know more about the vehicle than buyers
20
Q
imperfect information and market failure
A
- perfect information; when every market participant has complete knowledge
- imperfect information; when either the buyer or seller has incomplete information
- imperfect info leads to market failure due to a misallocation of resources, as people don’t buy things that maximise their welfare
- this can lead to under-provision or over-provision of a good, so price and quantity aren’t at the social optimum position
- the govt. can intervene to correct this market failure through indirect taxes (over-consumption), subsidies (under-consumption), provision of info, and regulation
21
Q
asymmetric info - insurance markets
A
- 2 aspects of asymmetric info in these markets;
- moral hazards; when consumers will take greater risks as they know a claim will be paid for by their insurance cover (consumer knows more about their intended actions than the producer)
- adverse selection; those most likely to purchase it are those who will most likely use it, e.g. smokers, drinkers, etc. for health insurance - the insurance company knows this, so raises average price of insurance cover, which prices healthy consumers out of the market (market failure)
