1.3 Market failure

Question 1

Market failure

Answer 1

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.

Question 2

externality

Answer 2

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.

Question 3

under provision of public goods

Answer 3

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.

Question 4

Information gaps

Answer 4

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.

Question 5

types of market failure

Answer 5

-assymetrical information
-lack of information
-public goods
-factor immobility
-negative and positive externalities
-equity issues

Question 6

assymetrical information

Answer 6

when one party has far more information than the other party and they use this to influence the market

Question 7

equity issues

Answer 7

-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

Question 8

private costs/benefits

Answer 8

the costs/benefits to the individual participating in the economic activity. The demand curve represents private benefits and the supply curve represents private costs.

Question 9

social costs/benefits

Answer 9

costs/benefits of the activity to society as a whole.

Question 10

external costs/benefits

Answer 10

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.

Question 11

MPB

Answer 11

marginal private benefit

Question 12

MPC

Answer 12

marginal private cost

Question 13

MSB

Answer 13

marginal social benefit

Question 14

MSC

Answer 14

marginal social cost

Question 15

positive externality

Answer 15

a positive impact on a third party. the problem right now is hat it’s under vlaued and under consumed

Question 16

negative externality

Answer 16

a negative impact on a third party outside the externality

Question 17

merit goods

Answer 17

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.

Question 18

government intervention (indirect taxes and subsidies)

Answer 18

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.

Question 19

government intervention (tradable pollution permits)

Answer 19

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.

Question 20

government intervention (provision of the good)

Answer 20

When social benefits are very high, the government may
decide to provide the good through taxation. They do this with healthcare and education.

Question 21

government intervention (provision of information)

Answer 21

Since some externalities are associated with information
gaps, the government can provide information to help people make informed decisions and acknowledge external costs.

Question 22

government intervention (regulation)

Answer 22

This could limit consumption of goods with negative externalities, for example banning advertising of smoking etc.

Question 23

public goods

Answer 23

they provide an example of market failure resulting from missing markets

Question 24

non-rivalry

Answer 24

which means that one person’s use of the good doesn’t stop someone else from using it

Question 25

non-excludable

Answer 25

meaning that you cannot stop someone from
accessing the good and someone cannot chose not to access the good.

Question 26

non-rejectable

Answer 26

the collective supply of public good for all means that it cannot be rejectred by other people

Question 27

quasi public-good

Answer 27

a near public good , it has many characterisitics of a public good but not all

Question 28

free rider problem

Answer 28

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.

Question 29

why don’t the private sector provide public goods

Answer 29

they can’t make a profit

Question 30

symmetric information

Answer 30

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

Question 31

assymetric information

Answer 31

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.

Question 32

why does information gaps lead to market failure

Answer 32

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.

Question 33

priciple agent problem

Answer 33

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

Question 34

economies of scale

Answer 34

where average cost falls the more you produce

Question 35

why should the state provide public goods?

Answer 35

-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

Question 36

rationaling decision making

Answer 36

people aim to maximise their own welfare but decisons are often made off incomplete information

Question 37

questioning rational behaviour

Answer 37

-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