1.3 - market failure Flashcards
What is market failure?
Market failure is where the market is unable to efficiently allocate scarce resources to meet the needs of society, causing a loss in social welfare.
What do classical economists believe about markets?
Classical economists believe that markets maximise economic welfare as the sum of producer and consumer surplus is maximised at equilibrium, though despite not always being socially optimal.
What are the three types of market failure?
There are three types of market failure: Externalities, Asymmetric information/information gaps, Public goods.
What does the marginal benefit curve show?
Marginal benefit curves shows the MPB, which falls with output due to consumers’ diminishing marginal utility and in a free market it is shown by the market demand curve, as well as the MSB which is what the market demand curve should look like to optimise social welfare.
What is marginal social benefit?
The additional utility gained by everyone in society from an individual consuming an additional unit of a good.
What is marginal private benefit?
The additional utility gained directly by the individual consuming an additional unit of a good.
What is marginal external benefit?
The additional utility gained by third parties from an individual consuming an additional unit of a good for their own benefit.
What is the formula for MSB?
MSB = MPB + MEB.
What are positive externalities?
A benefit experienced by a third party outside the market transaction, which is not reflected by the price mechanism. For consumption, it is accounted for in the marginal benefit curves where MSB > MPB.
What is a merit good?
A good with external benefits but are usually under-provided by the free market, where the benefit to society is greater than the benefit to the individual.
What does the marginal cost curve show?
Marginal cost curves shows the MPC, which rises with output as producers need more revenue to maximise factors of production and profit motive and in a free market it is shown by the market supply curve, as well as the MSC which is what the market supply curve should look like to optimise social welfare.
What is marginal social cost?
The additional cost incurred by everyone in society from society producing an additional unit of a good.
What is marginal private cost?
The additional burden incurred by firms producing an additional unit of the good.
What is marginal external cost?
The additional costs incurred by third parties gained by firms producing an additional unit of the good.
What is the formula for MSC?
MSC = MPC + MEC.
What are negative externalities?
A cost incurred by a third party outside the market transaction, which is not reflected by the price mechanism. For production, it is accounted for in the marginal cost curves where MPC > MSC.
What is a demerit good?
A good with external costs but are usually over-provided by the free market, where cost to society is greater than cost to the individual.
What are the characteristics of public goods?
Public goods are defined by their characteristics:
* Non-excludable - provision of a good means it is impossible to prevent people from using and benefiting from it and it can’t be rejected by the consumer.
* Non-rival - consumption of a good by one person does not prevent or reduce the benefits for others consuming the good as it doesn’t reduce the amount of goods available for others.
What is a pure public good?
A good that is non-excludable and non-rival all of the time, e.g. national defence, security, mass vaccination, flood defences, road signs, street lights.
What is a quasi-public good?
A good that has some, but not all public good characteristics, e.g. TV & radio broadcasting, toll roads, beaches.
What are public bads?
Goods that are non-excludable and non-rival but provide dissatisfaction to people who consume, e.g. flytipping, air pollution.
Why do private sector producers not provide public goods?
Private sector producers will not provide public goods to people as they arent 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 and financed through taxation.
How does taxation help provide public goods?
Taxation ensures that everyone contributes to the funding of public goods.
Why is producing public goods for a larger population more cost-effective?
Producing public goods for a larger population is more-cost effective as lower cost per capita.
How does government allocation of resources affect public goods?
Allows governments to allocate resources based on societal priorities, and maximises equity since governments don’t seek profit, public goods are made more affordable and accessible.
How can public goods create better business conditions?
Provision of some public goods can create better conditions for businesses - education, healthcare, infrastructure (roads, etc.), security
What is the free rider problem?
A free rider is someone who consumes a good without paying for it. As public goods are non-excludable, it is difficult to charge an individual a price for the provision of this good as someone else will gain the benefit from it without paying anything.
What is the assumption of perfect information?
It is assumed that consumers and producers have perfect information, allowing them to make rational decisions, however imperfect information can cause market failure due to information gaps.
What is symmetric information?
A situation where consumers and/or producers have potential access to the same information.
What are information gaps?
A situation where consumers and/or producers have incomplete information about the true benefits and costs of a good.
What is asymmetric information?
A situation in which one party in a transaction has more or better information than the other, usually the producer compared to the consumer.
How does advertising contribute to information gaps?
Most advertising leads to information gaps as it is designed to change attitudes of the consumers to encourage them to buy a good, causing them to think the benefits are greater than they actually are.
How has technology affected information gaps?
Increases in technology mean information gaps are on the decline as people can get more information.
