1.3 Market Failure Flashcards
What is market failure?
Market failure is when the price mechanism causes an inefficient allocation of resources.
How can market failure be caused? (3)
- Information gaps.
- Under-provision of public goods.
- Externalities.
What is an information gap?
An information gap is when the relevant economic agents involved in a market do not have symmetric information.
How can information gaps lead to a misallocation of resources?
Economic agents are incapable of making rational decisions without complete information. Therefore, the price that is paid by a consumer may not reflect the true worth of a good.
What is a public good?
The characteristics of a public good cannot be provided by the free market. Profit cannot be obtained from public goods, so there is no incentive for firms.
What is meant by non-excludability/the “free-rider” problem?
Individuals cannot be excluded from the use of a public good. Users cannot be charged for the benefit they receive from the good e.g. a street lamp.
What is meant by non-rivalry?
Consumption by one person of a good does not prevent consumption by another person.
What is an externality?
An externality is when the production or consumption of a good/service has an external impact on a third party.
What is a private cost?
A private cost is a cost experienced by the individual or firm that has consumed/produced the good/service.
What is a social cost?
A social cost is a cost experienced by a third party as a result of the consumption of a good/service by another party.
What is a negative externality?
A negative externality is when the marginal social cost exceeds the marginal private cost. The full cost implications to society are not borne by the private cost.
What is a welfare loss triangle?
Welfare loss triangles represent the accumulative lost welfare by the market equilibrium not being at Q*.
What is a positive externality?
A positive externality is when the marginal social benefit exceeds the marginal private benefit.
What is a social benefit?
A social benefit is the value to society as a result of the consumption of a good/service e.g. education.
What is a private benefit?
A private benefit is the utility gained by the consumer from a good/service.
