1.3 Market failure Flashcards
Market failure
occurs when the market fails to allocate scarce resources efficiently, causing a loss in social welfare loss. Two types are complete market failure and partial market failure.
externality
the cost or benefit a third party receives from an
economic transaction outside of the market mechanism. this leads to the over or under-production of goods, meaning resources aren’t allocated efficiently. For example, cars and cigarettes have negative externalities whilst education and healthcare have positive externalities.
under provision of public goods
Public goods are non-rivalry and non-excludable,
meaning they are underprovided by the private sector due to the free-rider problem. The market is unable to ensure enough of these goods are provided. One of the best
examples of a public good is streetlights.
Information gaps
firms are assumed to have perfect information on their cost and revenue curves and governments are assumed
to know the full cost and benefits of each decision. In reality, this is not the case. Therefore, economic agents do not always make rational decisions and so resources
are not allocated to maximise welfare.
types of market failure
-assymetrical information
-lack of information
-public goods
-factor immobility
-negative and positive externalities
-equity issues
assymetrical information
when one party has far more information than the other party and they use this to influence the market
equity issues
-income:
immediate access to money/cash. often earned through
being an employee or a business owner
-wealth:
ownership of assets such as land, buildings and
investment
private costs/benefits
the costs/benefits to the individual participating in the economic activity. The demand curve represents private benefits and the supply curve represents private costs.
social costs/benefits
costs/benefits of the activity to society as a whole.
external costs/benefits
he costs/benefits to a third party not involved in the economic activity. They are the difference between private costs/benefits and social costs/benefits.
MPB
marginal private benefit
MPC
marginal private cost
MSB
marginal social benefit
MSC
marginal social cost
positive externality
a positive impact on a third party. the problem right now is hat it’s under vlaued and under consumed
negative externality
a negative impact on a third party outside the externality
merit goods
a good with external benefits, where the benefit to society is greater than the benefit to the individual. These goods tend to be underprovided by the free market. A
demerit good is a good with external costs, where the cost to society is greater than the cost to the individual. They tend to be over-provided by the free market.
government intervention (indirect taxes and subsidies)
Taxes can be put on goods with negative externalities
and subsidies on goods with positive externalities. These help to internalise the externalities, moving production closer to the social optimum position.
government intervention (tradable pollution permits)
These allow firms to produce up to a certain amount of
pollution, and can be traded amongst firms so give them choice whilst reducing the total level of pollution.
government intervention (provision of the good)
When social benefits are very high, the government may
decide to provide the good through taxation. They do this with healthcare and education.
government intervention (provision of information)
Since some externalities are associated with information
gaps, the government can provide information to help people make informed decisions and acknowledge external costs.
government intervention (regulation)
This could limit consumption of goods with negative externalities, for example banning advertising of smoking etc.
public goods
they provide an example of market failure resulting from missing markets
non-rivalry
which means that one person’s use of the good doesn’t stop someone else from using it
non-excludable
meaning that you cannot stop someone from
accessing the good and someone cannot chose not to access the good.
non-rejectable
the collective supply of public good for all means that it cannot be rejectred by other people
quasi public-good
a near public good , it has many characterisitics of a public good but not all
free rider problem
This says that you cannot 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. A free rider is someone who receives the benefits without paying for it.
why don’t the private sector provide public goods
they can’t make a profit
symmetric information
where buyers and sellers have potential access to
the same information; this is perfect information. However, many decisions are based on imperfect information and so economic agents are unable to make an informed decision; they suffer from an information gap
assymetric information
one party has superior knowledge compared to
another. Usually, the seller has more information than the buyer and this means they can take advantage of the other party’s lack of knowledge, by charging them a higher
price.
why does information gaps lead to market failure
there is a misallocation of resources because people do not buy things that maximise their welfare. It means that consumer demand for a good or producer supply of a good may be too high or too low, and thus price and quantity are not at the social optimum position. Economic agents are unable to make rational decisions due to the information gap.
priciple agent problem
an arrangement in which one enitity legally appoints another to act on its behalf. the agents acts on behalf of the principal and should not have a conflict of interest in carrying out the act. this problem involves assymetrical information
economies of scale
where average cost falls the more you produce
why should the state provide public goods?
-non rival nature
-provided free at point of use due to taxation
-under provision and inder consumption is prevented, social welfare is maximised
–provide public goods affordable and more accessable
-government might become a monopoly provider, meaning there is a lack of efficency due to lack of competition
rationaling decision making
people aim to maximise their own welfare but decisons are often made off incomplete information
questioning rational behaviour
-have limited capacity to calculate all costs and benefits of a decision
-are influenced by social networks
-often act reciprocally rather than in their own pure self interest
-lack of self control and seek immediate satisfaction
-satisfice rather than maximise
