1.3 - Market Failure Flashcards
What are externalities?
An externality is the cost or benefit a third party receives from an economics transaction outside of the market mechanism. It is the ‘spill-over’ effect of the production or consumption of a good or service. This leads to the over or under-production of goods, meaning resources aren’t allocated efficiently.
What is meant by the under-provision of public 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.
What are information gaps?
Firms are assumed to have perfect information on their cost and revenue curves and governments are assumed to know the fill cost and benefits of each decision. This is not the case however, so economic agents do not always make rational decisions and so resources are not allocated to maximise welfare.
What are private costs/benefits?
The cost/benefit 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?
The cost/benefit of the activity to society as a whole.
What are external costs/benefits?
The cost/benefit to a third party not involved in the economic activity. They are the difference between private costs/benefits and social costs/benefits.
How can the government 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
What are the two characteristics of public goods?
- Non-rivalry
- Non-excludable
What does non-excludable mean?
You cannot stop someone from accessing the good and someone cannot chose not to access the good.
What does non-rivalry mean?
One person’s use of the good doesn’t stop someone else from using it.
What is the free-rider problem?
It says that you cannot charge an individual a price for the provision of a non-excludable good because someone will gain the benefit from it without paying anything. A free rider is someone who receives the benefits without paying for it.
Why can’t the private sector provide public goods?
They will not provide them because they will not 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 who can finance them through taxation.
What is symmetric information?
Symmetric information occurs when buyers and sellers have potential access to the same information; this is perfect information.
What is asymmetric information?
Asymmetric information occurs when one party has superior knowledge compared to another. Usually, the seller has more information than the buyer which means they can take advantage of the other party’s lack of knowledge, by charging them a higher price.
How does advertising lead to information gaps?
Advertising usually leads to information gaps as it is designed to change the attitudes of the consumers to encourage them to buy the goods. It could cause them to think the benefits are greater than they actually are. However, increases in technology mean information gaps are on the decline as people can get more information.
How do information gaps lead to a misallocation of resources?
Information gaps can lead to a misallocation of resources because people do not buy things that maximise their welfare. It means that consumer demand for a good or producer supply of a good may be too high or too low, and thus price and quantity are not at the social optimum position. Economic agents are unable to make rational decisions due to the information gap.
