1.3 Market Failure Flashcards
When does market failure occur?
When the free market fails to allocate resources to the best interest of society thus an inefficient allocation of resources
What are the 3 types of market failure?
- externalities
- under provision of public goods
- information gaps
What is an externality?
The cost of benefit a third party receives from an economic transaction outside of the market mechanism.
What are the 2 types of externalities?
Positive - external benefits
Negative - external costs
What are private costs?
The costs to economics agents involved directly in an economic transaction
- determining how much the producer will supply
- may refer to market price of good
What is a social cost?
Cost to the society as a whole
How are social costs calculated?
private costs + external costs
How are private costs shown diagrammatically?
- By the vertical distance between the two curves
- difference between private costs and social costs
- the MSC and MPC diverge from each other
What are private benefits?(3)
- Consumers are concerned with private benefits derived from the consumption of a good.
- the price the consumer is prepared to pay determines this
- private benefits could also be a firms revenue from selling a good
How do you calculate social benefits?
Private benefits + external benefits
How are external benefits shown diagrammatically?
External benefits are the difference between private and social benefits
- external benefits increase disproportionately as output increases
What is the social optimum position?
Where MSC=MSB, the point of maximum welfare
- social costs are made from producing the last unit of output is equal to the social benefit derived from consuming the unit of output
What are the government policies for negative externalities?(7)
- indirect taxes
- subsidies
- regulation
- provide the good directly
- provide information
- property right
- personal carbon allowances
How is the government policy, indirect taxes, used for negative externalities?(1+3)
To reduce the quantity of demerit goods consumed.
- by increasing price of the good
- the tax is = tot he external cost of each unit thus supply curve becomes MSC instead of MPC, so the free market equilibrium becomes the socially optimum equilibrium.
- this internalises the externality so the polluter pays for the damage
How is the government policy,subsidies, used for negative externalities?
To encourage the consumption of merit goods.
- including the full social benefit in the market price of the good
How is the government policy, regulation, used for negative externalities?
To enforce less consumption of s good.
- bans are only useful where MSC > MPB
How is the government policy of providing the good directly used for negative externalities?
The government could provide public goods which are under provided in the free market.
How is the government policy of proving information be used for negative externalities?
So there is no information failure, and consumers and firms can make informed economic decisions
How is the government policy of property rights, used for negative externalities?
To encourage innovation as entrepreneurs can create new ideas which are protected and earn profit.
How is the government policy, personal carbon allowances, used for negative externalities?
- they could be tradable so firms and consumers can pollute up to a certain amount, and trade what they don’t use.
What are public goods?
Items missing from the free market but offer benefits to the society.
- e.g. street lights, flood control systems are public goods
What is a non-excludable good?
When consuming the good, someone else is not prevented from consuming the good as well and they are non rival, so the benefit other people get from the good does not diminish if more people consume the good.
What effect does public goods have due to its non excludable nature?
Free-rider problem.
What is the free rider problem?
When people who do not pay for the good still received benefits from it in the same way people who pay for the good do.
Why are public goods under provided in the private sector?(2)
- They don’t make a profit from providing the good since consumers don’t see a reason for paying for it if they still receive the benefit without paying for it
- difficult to measure the value consumers get from public. Producers will over value the product while consumers under value it
What are private goods?
Goods that are rival and excludable
What is a Quasi Public good?
A non pure public good
- has characterised of both public and private goods
- partially provided by the free market
What is symmetric information?
Consumers and producers have perfect market information to make their decision.
Leading to an efficient allocation of resources
What is asymmetric information?
What is imperfect information
Where information is missing so an informed decision cannot be made
What does a misallocation of resources lead to?
Consumers paying too much or too little, firms producing the incorrect amount.
What is a principal agent problem?
When the agent makes decisions for the principal, but the agent is inclined to act in their own interest rather than those of the principal.
-e.g. shareholders and managers have different objectives which might conflict. Managers might choose to make a personal gain, rather than maximise the dividend of the shareholders
