1.3 Topic sheets

Question 1

What is market failure?

Answer 1

When free markets lead to an inefficient allocation of resources.

Question 2

What is meant by an externality?

Answer 2

A positive or negative impact on a third party who is not directly involved in a transaction.

Eg if someone is smoking in public this could have a negative externality on someone nearby.

Question 3

Define a negative externality?

Answer 3

A cost to someone is not involved in the transaction.

Question 4

Define a positive externality?

Answer 4

A benefit to someone who is not a part of the transaction. Eg vaccines herd immunity.

Question 5

Define private costs?

Answer 5

costs that are borne to the buyer or seller in the transaction.

Question 6

Give 3 examples of costs in production of a pencil?

Answer 6

The cost of wood, the cost of lead, the cost of the rubber for eraser.

Question 7

Define external costs?

Answer 7

A cost that is borne to someone that is not part of the transaction. Eg the noise pollution near and airport.

Question 8

Give two examples of the external costs in the production of a pencil?

Answer 8

1- The cutting down of trees to get wood could take a way a habitat for animals.
2- transporting the materials would create pollution.

Question 9

Define external benefits?

Answer 9

Benefits to a third party that are borne to those who are not part of the transaction.

Question 10

Define social costs?

Answer 10

Social cost= private costs+ external costs

Question 11

Define social benefits?

Answer 11

Social benefits= private benefits+ external benefits

Question 12

Define and give examples of a merit good?

Answer 12

A good that has a positive externality in consumption such as vaccines.

Question 13

Define and give examples of a demerit good?

Answer 13

A good that has a negative externality in consumption such as smoking.

Question 14

Define and give examples of a private good?

Answer 14

Private goods are goods that are provided by the free market.

Question 15

Draw a diagram showing positive externalities in consumption?

Answer 15

See notes attached.

Question 16

Draw a diagram showing negative externalities in consumption

Answer 16

See notes attached

Question 17

Draw a diagram showing positive externalities in production

Answer 17

See notes attached.

Question 18

Draw a diagram showing negative externalities?

Answer 18

See notes attached.

Question 19

What are missing markets?

Answer 19

Markets for goods that are not provided in the free market as they are not profitable to provide the free rider problem.

Question 20

Define and give examples of public goods?

Answer 20

Public goods are goods that are non-diminishable and non-excludable eg street lighting

Question 21

What is meant by non-excludable?

Answer 21

When the good cannot be provided to one consumers without another consumer benefitting from it. Eg when a street light is provided you cannot exclude the benefit from others.

Question 22

What is meant by non-diminishable?

Answer 22

When a good is consumed there is no less available for others to consume. Eg street light.

Question 23

What is the difference between a merit good and a public good?

Answer 23

A merit good is one that has positive externalities in consumption. Compared to a public good that is non-excludable and non-diminishable. Merit goods are underconsumed in the free market and underproduced. Public goods are not provided in the free market.
Both are provided by the government or in the way of subsidies.

Question 24

What is meant by asymmetric information?

Answer 24

When there is unequal information between the consumer and the producer.

Question 25

Give examples of 3 asymmetric information?

And explain how they are?

Answer 25

Second hand car dealership.
Cowboy builders (low qualifications).
Dentist.
This is because they have information

Question 26

How can asymmetric information cause market failure?

Answer 26

The lack of information can cause an inefficient allocation of resources as consumption or production decisions will not be made on the full facts leading to mistakes which do not maximise utility.

Question 27

How can asymmetric information cause adverse selection?

Give 2 examples of this?

Answer 27

This is when good consumers drop out of a market because other consumers in a market cause to rise in a market

Question 28

How does adverse information give rise to asymmetric information?
What is an example of this?

Answer 28

Adverse selection is when “good consumers” drop out of a market when the behaviour of other consumers cause prices to drive up above what “good” consumers are willing to pay.
This is clear in the health insurance as the consumer knows if they are a peach or a lemon. Therefore, the insurance company sets the insurance premium high as they do not know who is a lemon. Consequently, the price is driven up above how much the peaches are willing to pay.

Question 29

How does asymmetric information give rise to moral hazard?

Answer 29

Moral hazard is when the free-market gives rise to sub-optimal way. For example if an individual has health insurance they will be less likely to look after belongings.
Or if someone has health insurance so they take less care of health.