1.3 Market Failure

Question 1

What is a market failure?

Answer 1

Market failure occurs when the market fails to allocate scarce resources efficiently, causing a loss in social welfare loss/deadweight loss/triangle

Question 2

What is an externality?

Answer 2

A cost or benefit incurred to a third party not involved in the economic activity itself (spillover!)

Question 3

What is a public good?

Answer 3

Public goods are non-rivalry and non-excludable, meaning they are underprovided by the private sector due to the free-rider problem

Question 4

What does non rivalrous mean?

Answer 4

its consumption by one consumer prevents simultaneous consumption by other consumers

Question 5

What does non excludable mean?

Answer 5

impossible to prohibit any person from using the good.

Question 6

What is the free-rider problem?

Answer 6

market failure that occurs when those who benefit from resources as non rivalrous and non excludable.

Question 7

Information gaps in externalities

Answer 7

(1) Difficult to estimate the size of externality and therefore size of tax
(2) Resources are not optimally allocated as should be since firms don’t actually know the full extent to their cost curves and consumers their preferences.

Question 8

What are private costs / social costs / external costs? (benefits vice versa)

Answer 8

costs/benefits to: individual, society, and third party.

Question 9

Definition of MPB / MSB

Answer 9

Marginal benefit gained by individual / society from consuming one more good

Question 10

Definition of MPC / MSC

Answer 10

Marginal cost by individual / society from consuming one more good

Question 11

Draw/analyse a negative/positive consumption externality

Answer 11

THEME 1 MICRO DOC
CHECKLIST:
- Deadweight loss
- D = MSB = MPB
- MSC and MPC as supply curves
- MSB and MPB as demand curves

Freemarket is underproducing at Qe, welfare gain to be had at Qoptimum.
More allocatively efficient if society shifts factors of production (via government intervention) to optimum.

Question 12

Draw/analyse positive and negative production externality diagram

Answer 12

THEME 1 MICRO DOC
CHECKLIST:
- Deadweight loss
- D = MSB = MPB
- MSC and MPC as supply curves
- MSB and MPB as demand curves

SPECIFIC NOTES:

MPC on left and MSC on right
Want to shift curve right (for positive) not left (for negative.)

(1) Negative externalities of production exist when the social costs are greater than the private costs freely ignoring cost of good to society and not internalising this in the cost of the good.
(2) They produce where MSB = MPC and so theres an over consumption of the good at Q1 instead of Q2 and P1 is lower than P2 to highlight cost not being fully internalised.

Question 13

What are the types of market failure?

Answer 13

Sources of market failure include the existence of externalities, an under-provision of public goods, and the existence of information gaps in markets

Externalities:
- External costs that aren’t internalised by buyer

Public goods:
- These are goods that are good for society but are underprovided by the free market.
- Represented on a positive production/consumption (education would be example) externalities

Information gaps:
- Underlying assumption of free markets is equal information between buyer and consumer but not often the case (peaches and lemons.)

Question 14

Does MSB and MPB a production or consumption externality diagram, and how do you tell?

Answer 14

It needs a consumption diagram. You can tell because they represent the demand curves and demand relates to consumption. The supply curves (MPC and MSC) represent production (of the good.)

Question 15

What type of inefficiency do externalities cause and why?

Answer 15

Allocative inefficiency - Allocative efficiency refers to the optimal allocation of resources but be achieved due to the divergence between private and social costs/benefits

Question 16

What are the difficulties of externalities?

Answer 16

1. It is difficult to measure the size of them
2. It is difficult to regulate any measures to counteract them
3. Firms have large legal teams that may make any enforcement of regulation difficult
4. Typically information gaps with their consumption and so people don’t know full cost of the externality.

Question 17

How do firms lock out consumers from their goods (and therefore excludable)

Answer 17

Through the price mechanism with prices, meaning only those that want to purchase the goods can receive them.

Question 18

How do information gaps lead to externalities?

Answer 18

People aren’t aware of the externalities of their consumption of the good leading to spillover effects.
Asymmetric information allows sellers to distort the prices of their goods like dangerous side effects.

Question 19

Difference between public goods and merit goods?

Answer 19

Public goods (for the public!) suffer from provision due to the free rider problem (both non-rivalrous and non-excludable.)

Merit goods, on the other hand, are goods that have positive externalities but still an under-provision of them exist (like education.)