1.3 MARKET FAILURE

Question 1

i. What is the definition of market failure?

Answer 1

-When the free market fails to allocate scarce resources at the socially optimum level of output

Question 2

iii. What is the overproduction or underproduction of a good known as?

Answer 2

-Partial market failure

Question 3

name all the types of market failures

Answer 3

1) negative externalities, - self interest

2) positive externalities - self interest

3) De-merit goods - information failure

4) Merit goods - information failure

5) Public goods - free rider problem

6) Common access to resources - self interest

7) income inequality - inequity

8) Monopoly power - One dominant seller and high barrier to entry

9) Factor immobility

Question 4

i. What is an external benefit?

Answer 4

-the benefit gained by an individual or firm as a result of an economic transaction but where they are not directly involved in the transaction

Question 5

ii. What is an external cost?

Answer 5

-a cost not included in the market price of the goods and services being produced

Question 6

iii. What is a social benefit?

Answer 6

-transfers made (in cash or in kind) to persons or families to lighten the financial burden of protection from various risks

Question 7

iv. What is a social cost?

Answer 7

-the sum of the private costs resulting from a transaction and the costs imposed on the consumers as a consequence of being exposed to the transaction for which they are not compensated or charged

Question 8

i. What are the 2 necessary conditions for public goods?

Answer 8

-non-rivalrous and non-excludable

Question 9

iii. What is non-excludability? Use an example in your answer

Answer 9

-Non-excludablegoods refer to public goods that cannot exclude a certain person or group of persons from using such goods. E.g. Public parks (no price can be charged for them)

Question 10

iv. What is non-rivalry? Use an example in your answer

Answer 10

-Non-rivalry means thatconsumption of a good by one person does not reduce the amount available for others. E.g. Air (the quantity of good doesn’t diminish upon consumption

Question 11

v. What is the free rider problem?

Answer 11

-the burden on a shared resource that is created by its use or overuse by people who aren’t paying their fair share for it or aren’t paying anything at all

Question 12

vi. Are public goods under- or over-consumed in the free market? Why?

Answer 12

-Public goods problems are often closely related to the “free-rider” problem, in which people not paying for the good may continue to access it. Thus,the good may be under-produced, overused or degraded

Question 13

vii. Give a reason why governments may choose not to provide public goods

Answer 13

-Public goods create market failuresif a section of the population that consumes the goods fails to pay but continues using the good as actual payers

Question 14

i. What is information asymmetry?

Answer 14

-an imbalance between two negotiating parties in their knowledge of relevant factors and details

Question 15

ii. Why information asymmetry a form of market failure?

Answer 15

-consumers look to maximise utility and it can cause people to act irrationally (

Question 16

Merit goods

Answer 16

A merit good isa good which when consumed provides external benefits, although these may not be fully recognised
– hence the good is under-consumed. Examples include education and healthcare

(not enough information regarding how good so it is under consumed)

Question 17

Demerit goods

Answer 17

Ademerit good
is defined as a good which can have a negative impact on the consumer – but these damaging effects may be unknown or ignored by the consumer.

(not enough information about how bad it is so it is over consumed)

Question 18

iii. What is adverse selection?

Answer 18

-buyers or sellers of a product or service are able to use their private knowledge of the risk factors involved in the transaction to maximize their outcome