1.3 - market failure Flashcards
what happens when markets work perfectly?
-supply and demand allocate resources
-the most efficient allocation of resources is achieved
-the best available solution to the economic problem is achieved
what are scarce resources?
-the factors of production
LLCE
what is equilibrium?
-a state of balance between demand and market supply
what does market failure lead to?
-either an over provision or an under provision
-over or under allocation
sources of market failure?
-existence of externalities
-under provision of public goods
-existence of information gaps
why don’t markets work perfectly?
-irrational behaviour
-lack of information
-lack of competition
-inequality
-markets that misallocate resources
-missing or absent markets
what is an externality?
-spill over effects from production or consumption
-when there is an external impact on a third party
when do external costs occur?
-when the social costs of an economic transaction are greater than the private costs
what is a private cost?
-costs faced by the producer or consumer directly involved in the economic transaction
what is an external cost?
[negative externality]
-the damage not factored into the economic activity
calculate social cost?
Private cost + external cost
when do external benefits occur?
[positive externality]
-when the social benefits are greater than the private benefits
calculate social benefit?
-private benefit + external benefit
how are negative externalities of production causing market failure?
-due to over-provision
-only PC ate being considered
-if EC were considered, the qty of goods/services would decrease and be sold at a higher price
1.3.2
what does marginal analysis consider?
–the cost/benefit of the next unit produced/consumed
what is MPC?
-marginal private cost
-cost of next unit consumed/produced
what is MPB?
-marginal private benefit
examples of government intervention?
-indirect taxes
-legislation
-regulation
-force market to be more socially efficient
-can reduce welfare loss
what do positive externalities of consumption result in?
-an under-consumption
-free market failing due to under consumption
what does welfare loss triangle show?
-more FOP should be allocated to producing the optimal quantity as societal welfare will be gained
shadow pricing?
[valuing externalities]
-a means of estimating the effect of an externality by calculating a potential price of lost opportunities
compensation?
-estimate the cost of ‘putting it right’ for an externality
revealed preference?
-how much people are willing to pay to avid an externality
negatives on third parties associated with high levels of alcohol consumption?
-more accidents
-increase in need for other public services eg healthcare
-anti-social behaviour
-decrease in productivity
taxing a negative consumption externality?
-left shift of MPB to MSB
-left shift MSC to MSC+tax
1.3.3 [public goods]
what does a public good have to have?
-non-excludability
-non-rivalry
-can cause market failure due to problem of market failure
non-excludability?
-cannot be confined to those who have paid for it
-can create free-rider problem
non-rival consumption?
-each party’s enjoyment of the good/service does not diminish others enjoyment
-the marginal cost of supplying a public good to an extra person is 0
non-rejectable?
-the collective supply of pure public goods for all means it cannot be rejected by people
eg nuclear defence system
what is a quasi-public good?
-have some characteristics of a public good
semi non rival
semi non excludeable
semi non-rival?
-up to a point consumers using a park = eventually become crowded
semi non-excludable?
-it is possible but difficult or costly to exclude non-paying consumers
who usually provides public goods?
-governments
-must estimate net social benefits
free rider problem?
-because we don’t charge for it, no incentive to provide it –> leads to an under-provision of public goods –> market failure
demerit goods?
-MPB shifts left to MPB1
-effect on individual lower than originally thought
-info failure–>don’t believe it will impact them
-over consumption
-regulations and laws could close the gap eg with financial incentive, education
-example = alcohol
merit goods?
-MPB shifts right to MPB1
-causes more benefit than perceived
-under provision/misallocation of public goods
-example = education
1.3.4 [info gaps]
symmetric information?
-when everyone has the same info
asymmetric info?
-one person has more knowledge than the other
-taking advantage - info gaps
-leads to a misallocation of resources
causes of information gaps?
-misunderstanding cost/benefits
-complex information
-habitual purchase
-addiction [lack of awareness]
how do info gaps lead to market failure?
-people don’t maximise their welfare
moral hazard?
-likely to occur when consumers are likely to take greater risks knowing they are insured
-consumer knows about intended actions
adverse selection?
information asymmetry
ie healthcare insurance
ways to avoid market failure?
-less complex info
-advertising
-education
-tax + subsidies
-direct gov provision
-product info
