1.3 - Market failure

Question 1

What is the definition of market failure?

Answer 1

Where the market system fails to allocate resources efficiently.

Question 2

Why does market failure occur?

Answer 2

Because the price mechanism has not taken into the benefits/costs of the production or consumption of a good or service.

Question 3

What are the 3 market failures covered in this topic?

Answer 3

Externalities.

Non-provision of public goods.

Information gaps.

Question 4

What are externalities?

Answer 4

Costs and benefits to third parties who are not directly part of the transaction between producers and consumers.

Question 5

What are the 2 types of externalities?

Answer 5

Positive externalities - have a positive impact on third parties. (underproduced)

Negative externalities - have a negative impact on third parties. (overproduced)

Question 6

What are private costs?

Answer 6

The direct cost to the producer and consumer in the transaction.

Question 7

Give an example of a private cost to producers and consumers.

Answer 7

Producers - having to pay wages.

Consumers - price paid for a good or service.

Question 8

What are external costs?

Answer 8

Costs to third parties, i.e. individuals not involved in the transaction.

Question 9

Give an example of an external cost caused by producers and consumers.

Answer 9

Producers - noise/air pollution from factories.

Consumers - passive smoking.

Question 10

What are social costs?

Answer 10

Private costs + external costs

Question 11

NOTE TO SELF:

Answer 11

Revise negative externality graph!

Question 12

What are private benefits?

Answer 12

Benefits received directly by the producer and consumer in a transaction.

Question 13

Give an example of a private benefit to a producer and consumer.

Answer 13

Producer - revenue received from sales.

Consumer - the utility gained from the consumption of a good or service.

Question 14

What are external benefits?

Answer 14

Benefits to third parties, i.e. individuals not involved in the transaction.

Question 15

Give an example of an external benefit caused by producers and consumers.

Answer 15

Producers - switching to using more eco-friendly machinery.

Consumers - individuals getting vaccination can prevent the spread of disease.

Question 16

What are social benefits?

Answer 16

Private benefits + external benefits

Question 17

NOTE TO SELF:

Answer 17

Revise positive externality graph!

Question 18

What is the definition of a public good?

Answer 18

A good that is both rivalrous and non-excludable.

Question 19

What does the term non-rivalrous mean?

Answer 19

Consumption by one person does not limit consumption by another.

Question 20

What does the term non-excludable mean?

Answer 20

If a good is available for one person it is available for everyone.

Question 21

Give 3 examples of pure public goods.

Answer 21

Street lighting.

Defence systems.

National parks.

Question 22

What is a quasi public good?

Answer 22

These are goods that have some elements of public goods.

Question 23

Why would the private sector not provide public goods?

Answer 23

They are non-excludable meaning it is very hard to charge individuals and therefore make a profit, this is not sustainable.

Question 24

What is the free rider problem?

Answer 24

Once provided, it is impossible to prevent others from using the public good, therefore impossible to charge for it.

Question 25

What is symmetric information?

Answer 25

Where both parties in a transaction have the same information.

Question 26

What is asymmetric information?

Answer 26

Where one party in a transaction has more or superior information compared to the other.

Question 27

Give 2 real life scenarios where asymmetric information could occur.

Answer 27

Housing market - estate agents know more about the potential problems of a house than the potential buyer.

Second-hand car sales - the car sales person knows more about the car than the potential buyer.