1.3 market failure Flashcards
what is market failure?
occurs when the market fails to allocate scarce resources efficiently, causing a loss in social welfare loss
what are the three main types of market failure?
•externalities
•under provision of public goods
•information gaps
what is an externality?
the cost or benefit a third party receives from an economic transaction outside of the market mechanism e.g cigarettes have negative externalities
what is the under provision of goods?
-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 e.g streetlights
what are private costs/benefits?
-private costs/benefits are the costs/benefits to the individual participating in the economic activity
-the demand curve represents private benefits and the supply curve represents private costs
what are social costs/benefits?
social costs/benefits are the costs/benefits of the activity to society as a whole
what are external costs/benefits?
external costs/benefits are the costs/benefits to a third party not involved in the economic activity
-they are the difference between private costs/benefits and social costs/benefits
what is a merit good?
-a merit good is a good with external benefits, where the benefit to society is greater than the benefit to the individual
-tend to be underprovided by the free market
what is a demerit good?
-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
5 ways the government can intervene to ensure the market considers the external costs and benefits
-indirect taxes and subsidies
-tradable pollution permits
-provision of the good
-provision of information
-regulation
the two key characteristics of public goods
-they are non-rivalry, which means that one person’s use of the good doesn’t stop someone else from using it
-they are also non-excludable, meaning that you cannot stop someone from accessing the good and someone cannot chose not to access the good
what is the free rider problem?
- a free rider is someone who receives the benefits without paying for it e.g people who listen to music from a concert without paying for a ticket
why do we need public goods?
-private sector producers will not provide public goods to people because they cannot be sure of making a profit, due to the non-excludability of public goods
-therefore, if the provision of public goods was left to the market mechanism, the market would fail and so they are provided by the government and financed through taxation
what is symmetric information?
-occurs 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
what is asymmetric information?
-asymmetric information is when 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
