1.3 Market Failure Flashcards
Market failure
Where the market fails to allocate scarce resources efficiently
Externalities
The cost or benefit a third party receives from an economic transaction (spillover effect)
Positive externality
An external benefit to a third parry where SB exceeds PB. The market mechanism charges a price too high and fails to recognise all the benefits
Negative externality
An external cost to a third party where SC exceeds PC. The market mechanism charges a price too low and fails to recognise all the costs
Private costs/benefits
The costs/benefits to the individual participating in the economic activity
Social costs/benefits
The costs/benefits of the activity to societies as a whole
External costs/benefits
The costs/benefits to a third party not involved in the economic activity
Merit good
A good with external benefits (positive externalities) where the MSB is greater than the MPB. These are usually under provided by the free market and under consumed as consumers fail to recognise the full benefits
Demerit good
A good with external costs (negative externalities) where the MSC is greater than the MPC. They tend to be over provided by the free market and over consumed as consumers fail to recognise the full costs
Net welfare gain
Where social benefits exceed the social costs
Net welfare loss
Where social costs are greater than social benefits
Socially optimal point
The target point to eliminate externalities where MSB=MSC
Market equilibrium
Where private costs = private benefits (s=d)
Marginal cost/benefit
The extra cost/benefit of producing /consuming one extra unit of a good
Marginal private benefit
The extra satisfaction gained by the individual from consuming one more of a good
Marginal social benefit
The extra gain to society from the consumption of one more good
Marginal private cost
The extra cost to the individual from producing one more of a good
Marginal social cost
The extra cost to society from the production of one more good
Public goods
Goods that are non rivalrous and non excludable but are under provided by the market due to there being no profit incentive
Non rivalry
One persons use of the good does not stop someone else from using it
Non excludable
You cannot stop someone from accessing the good and someone cannot choose not the access the good
Private goods
Goods provided by the market mechanism which are rivalrous and excludable
Quasi public good
A good or service that displays some but not all the characteristics of a public good e.g a busy road
Free rider problem
Someone may receive the benefit of good that they haven’t paid for e.g reading a newspaper on the train that someone else has bought and is also reading
Information failure
Where consumers, producers or the government fail to recognise the full costs or benefits of consumption our production.
Symmetric information
Occurs where buyer and sellers have potential access to the same information
Asymmetric information
Where one party has superior knowledge to another (usually the seller)
What leads to info gaps
Most advertising leads to info gaps as it is designed to change attitudes of the consumer to encourage them to buy the good (however increased technology= less info gaps)
Info gaps causing market failure
There is a misallocation of resources as people do not buy things to maximise their welfare. Consumer demand may be too high or low for a product leading to price and quantity not being at the socially optimal point. Economic agents unable to make rational decisions due to info gaps
Principal-agent problem
The goals of the person who gains or loses from the decision are different from those making the decision on behalf of the principle
