1.3 - Market Failure Flashcards
Types of market failure
- Externalities
- Under-provision of public goods
- Information gaps
Externality
The cost or benefit a third party receives from an economic transaction outside of the market mechanism. This leads to the over or under-production of goods, meaning resources aren’t allocated efficiently
Public goods
Goods that are non-rivalrous and non-excludable goods or services, meaning they are underprovided by the private sector due to the free-rider problem
Free-rider problem
When individuals benefit from a good or service without paying for it, leading to under-provision or market failure in a free market
Information gaps
When buyers and sellers do not have access to complete or accurate information, leading to imperfect decision-making and potential market failure
Private costs
The costs to the individual participating in the economic
activity, with the supply curve representing private costs
Private benefits
The benefits to the individual participating in the economic
activity, with the demand curve representing private benefits
Social costs
The costs of the activity to society as a whole
Social benefits
The benefits of the activity to society as a whole
External costs
The costs to a third party not involved in the economic activity
External benefits
The benefits to a third party not involved in the economic
activity
Merit good
A good with external benefits, where the benefit to society is greater than the benefit to the individual, these tend to be underprovided and under consumed in a free market
Demerit good
A good with external costs, where the cost to society is greater than the cost to the individual, these tend to be over provided and over consumed in a free market
Negative externalities of production
When social costs are greater than private costs
Positive externalities of consumption
When social benefits are greater than social costs
Government intervention for negative externalities
- Indirect taxes and subsidies
- Tradable pollution permits
- Provision of the good
- Provision of information
- Regulation
Symmetric information
Where buyers and sellers have potential access to the same information, this is perfect information
Asymmetric information
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
Market failure
When the free market fails to allocate resources efficiently, leading to overconsumption, under consumption or misallocation of resources. This results in a loss of economic and social welfare
