1.3 Market Failure Flashcards
When does market failure occur
Market failure occurs when the market fails to allocate scarce resources sufficiently. Causing a loss in social welfare loss
What are the three types of market failure
Externalities
Under-provision of public goods
Information gaps
What is an externality
An externality is the cost or benefit a third party receives from an economic transaction outside of the market mechanism. In other words, the spillover effect of the production or consumption of a good or service.
What is 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 produced
E.g. streetlights
What is information gaps
Homo economics is assumed to have perfect information, allowing them to make rational decisions. Similarly, firms are assumed to have perfect info in their cost and revenue curves and governments are assumed to know the cost and benefits of each decision. In reality, this is not the case. Therefore, consumers do not always make rational decisions and so resources are not allocated to maximise welfare.
What are private costs/benefits
The costs/benefits to the individual participating in the economic activity.
What does the supply and demand curve represent in terms of private costs and benefits
The demand curve represents private benefits and the supply curve represents private costs
What are social costs / benefits
The costs/benefits of the activity to society as a whole
What are external costs / benefits
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 food is a food with external benefits,where the benefit to society is greater than the benefit to the individual
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, ususally overprovided by the free market
What are marginal costs / benefits
A marginal cost / benefit is the extra cost/benefit of producing / consuming one extra unit of the good.
What is marginal private cost
The extra cost to the individual from producing one more of the good
What is marginal social costs
Marginal social cost is the extra cost to society from the production of one more good
When do negative externalities of production occur
Occur when social costs are greater than private costs
Where on the externalities graph should the economy produce
Where MSB=MSC
When do positive externalities of consumption occur
Occur when more social benefits are created than social costs.
What ways can the government intervene to ensure the market considers the external costs and benefits
• Indirect taxes and subsidies- taxes on goods with negative externalities and subsided on goods with positive externalities
• tradable pollution permits - allow firms to produce up to a certain amount of pollution. Can be traded among firms
• provision of the good - when social benefits are very high, the government may decide to provide the good through tax. Healthcare and education
• regulation - limit the C of goods with negative externalities.
Key characteristics of public goods
• Non rivalry - one persons use of the good doesn’t stop someone else from using it
• non-excludable - cannot stop someone from accessing the good and someone cannot chose not to access to good
Streetlights are an example
What are quasi-public goods (non-public goods)
Good which aren’t perfectly non-rivaly and non-excludable but aren’t perfectly rival or excludable. One example is roads.
What is the free rider problem
You cannot charge an individual a price for the provision of a non-excludable food because someone else will benefit from it without paying
A free rider is a person who received the benefits of something without paying
What is the problem with public goods
Private sector producers will not make a profit due to the non-excludability of the good. Therefore if it was left to the market, the market would fail so they are provided by the government
What is symmetric information
Symmetric information occurs where buyers and sellers have potential access to the same information; this is perfect info. However, many decisions are based on imperfect information and so economic agents are unable to make an informed decision; they suffer from an info gap
What is asymmetric information
When only one party has superior knowledge compared to another. Usually, the seller has more info than the buyer and this means they can take advantage over the lack of knowledge of the other buyer, usually by charging higher prices
What has lead to info gaps
Advertising has led to info gaps as it is designed to change attitudes of the consumers to encourage them to buy the good. It could cause them to think the benefits are greater than they actually are.
What has led to a decrease in information gaps
Increased technology has led to a decrease in info gaps as people can get more info
Why do information gaps lead to market failure
As there is a misallocation of resources because people do not buy things that maximise their welfare.
Examples of info gaps
Drugs, where users do not see the long term problems
Pensions, where young people don’t see the benefits of paying into their pension schemes
Financial services, where the suppliers have more info than the consumers so abuse their customers for their own benefit
What is the principle agent problem
When the goals of the principle (the person who gains or loses from the situation) are different from the agents (those making decisions on behalf of the principle.
