1.3 Market Failure

Question 1

When does Market failure occur ?

Answer 1

When the market fails to allocate scarce resources efficiently, causing a loss in social welfare.

Question 2

What are the 3 main types of market failure ?

Answer 2

• Externalities
• Under-provison of public goods
• Information gaps

Question 3

What are externalities ?

Answer 3

Externalities are unintended side effects of economic activities that affect third parties who are not part of the transaction.

Question 4

What are the two types for externalities ?

Answer 4

They can be positive (benefits)
or negative (costs).

Question 5

Give two examples of positive externalities ?

Answer 5

Education
Healthcare

Question 6

Give two examples of negative externalities.

Answer 6

Smoking
Cars

Question 7

Explain how the under-provision of public goods shows market failure .

Answer 7

Public goods are non-rivalry and non-excludable meaning they are under provided by the private sector due to the free rider problem . The market is unable to ensure that enough of these goods are provided.

Question 8

Why do information gaps arise ?

Answer 8

Information gaps arise when one party in a transaction has more or better information than the other party.

Question 9

What are the consequences of asymmetric information ?

Answer 9

It can lead to adverse selection and moral hazard problems.

Question 10

What is adverse selection ?

Answer 10

When the expected value of a transaction is known more accurately by the buyer or the seller due to an asymmetry of information; e.g. health insurance.

Question 11

What is a moral hazard ?

Answer 11

Moral hazard arises when one party, protected by a contract or insurance, takes on riskier behavior because they are not fully accountable for the consequences.

When individuals or firms are insured against losses, they may engage in riskier activities than they would in the absence of insurance.

Question 12

What are private costs / benefits ?

Answer 12

Costs / benefits incurred by producers or consumers directly involved in a transaction or economic activity.

Question 13

On an externality graph, what does the demand and supply line refer to ?

Answer 13

The demand curve represents private benefits.
The supply curve represents private costs.

Question 14

What are social costs / benefits ?

Answer 14

Social costs / benefits represent the total costs of an economic activity of society, including both private costs and external costs.

Question 15

What are external costs / benefits ?

Answer 15

External costs are costs imposed on third parties who are not part of the transaction or activity.

Question 16

How are external benefits / costs calculated ?

Answer 16

They are the difference between private costs/benefits and social benefits/benefits.

Question 17

Explain what a merit good is in terms of external benefits.

Answer 17

A merit good is a good with external benefits, where the benefit to society is greater than the benefit to the individual.

Question 18

Explain what a demerit good is in terms of external benefits.

Answer 18

A demerit good is a good with external goods, where the cost to society is greater than the cost to the indiviual.

Question 19

Which goods tend to be over-provided / under-provided in the market ?

Answer 19

Demerit goods - over provided
Merit goods - under provided

Question 20

What is meant by the marginal cost / benefit ?

Answer 20

The extra cost/benefit of producing / consuming one extra unit of the good.

Question 21

What is marginal private benefit ?

Answer 21

MPB - extra satisfaction gained by the individual from consuming one more of a good.

Question 22

What is marginal social benefit ?

Answer 22

Extra gain to society from the consumption of one good.

Question 23

What is marginal private cost ?

Answer 23

The marginal private cost is the extra cost to the individual from producing one more of a good.

Question 24

When do negative externalities occur ?

Answer 24

When social costs are greater than private costs.

Question 25

Where is equilibrium on an externalities diagram ?

Answer 25

Where MPB = MPC

Question 26

When do positive externalities occur ?

Answer 26

When social benefits are greater than social costs.

Question 27

What form does Government intervention take to deal with externalities ?

Answer 27

• Regulation of demerit goods
• Indirect taxes and subsidies ( subsides for merit goods )
• Provision of the good through taxation
• Provision of information - so people make informed decisions .

Question 28

What are the impacts of negative externalities ?

Answer 28

Producers may not fully account for external costs, leading to overproduction of goods with negative externalities.
Consumers may not fully consider external costs, leading to overconsumption.
Overall, negative externalities can result in market inefficiencies and reduced social welfare.

Question 29

What are the impacts of positive externalities ?

Answer 29

Producers may not capture all external benefits, leading to underproduction of goods with positive externalities.
Consumers may not fully appreciate external benefits, leading to underconsumption.
Overall, positive externalities can

Question 30

What are the characteristics of private goods ?

Answer 30

Private goods are characterized by two key features: rivalry and excludability.

Question 31

What are the two characteristics of a public good ?

Answer 31

Non-rivalrous
Non-excludable

Question 32

What does ‘non-rivalrous’ mean ?

Answer 32

Means that one person’s use of the good does not stop someone else from using it.

Question 33

What does ‘non-excludable’ mean ?

Answer 33

Meaning that you can stop someone else from accessing the good and someone can not chose to not access the good.

Question 34

What are quasi-public goods ?

Answer 34

Some goods exhibit characteristics of both public and private goods. These are referred to as quasi-public goods.
They may have elements of non-rivalry or non-excludability but not to the same extent as pure public goods.

Question 35

What is the free rider problem ?

Answer 35

Where people receive benefits without paying for a good.

Question 36

Why do private sector producers not produce public goods ?

Answer 36

They can not be sure of making a profit due to non-excludability nature of the good.

Question 37

Who provides public goods ?

Answer 37

The government - financed through taxation.

Question 38

What is symmetric information ?

Answer 38

Symmetric information occurs when all parties in a transaction have equal access to information about the product, service, or market.
In a symmetric information scenario, buyers and sellers possess the same information, leading to transparent and well-informed decision-making.

Question 39

What is asymmetric information ?

Answer 39

Asymmetric information exists when one party in a transaction has more or better information than the other party.
This information imbalance can create problems, as the party with less information may make decisions based on incomplete or inaccurate data.

Question 40

How may imperfect information lead to market failure ?

Answer 40

Adverse selection
Moral Hazard

Question 41

How do information gaps lead to market failure ?

Answer 41

People do not buy things that maximise thier welfare - meaning consumer demand / producer supply may be too high or to low for some thing.

Question 42

What is the principle agent problem ?

Answer 42

When the goals of the Principle ( person who gains/loses from the decision ) are different from the agents.
Education being an example.

Question 43

What is the role of government and regulation in reducing information gaps ?

Answer 43

Governments often implement regulations and disclosure requirements to mitigate the impact of information asymmetry.
These measures aim to provide consumers with better information and promote transparency in markets.

Question 44

What is the other term for internal benefits / costs ?

Answer 44

private costs / benefits

Question 45

How are social cost calculated ?

Answer 45

Internal costs + external costs

Question 46

How are social benefits calculated ?

Answer 46

Internal benefits + external benefits

Question 47

What what does a margin refer to ?

Answer 47

It considers what would happen if the variable increases or decreased by one unit.

Question 48

What labels are on the axis for marginal cost benefits diagrams ?

Answer 48

Y can be wither price or costs & benefits
X is out put

Question 49

What does the demand curve represent on a marginal cost benefit diagram ?

Answer 49

Marginal private benefit

Question 50

What does the supply curve represent ?

Answer 50

Marginal private cost.

Question 51

When there are no externalities…..

Answer 51

Private costs and benefits = social costs and benefits

Question 52

What curve shifts for a production externalities ?

Answer 52

Cost curve - move for production externalities
Benefit curve - move for consumption.