1.3.1, 1.3.2, 1.3.3, 1.3.4 Market failure

Question 1

What is market failure?

Answer 1

Where the free market fails to achieve an optimum allocation of resources (misallocation of resources)

Question 2

In theory, what should the free market achieve?

Answer 2

The free market should allocate resources effectively and efficiently via the price mechanism/’invisible hand’

Question 3

What are the types of market failure? (3)

Answer 3

1) Externalities
2) Under-provision of public goods
3) Information gaps

Question 4

Define externalities

Answer 4

Spillover effects (costs/benefits) borne to the innocent third party as a result of consumption or production (economic transaction)

Question 5

Define positive externalities

Answer 5

External benefits to a third party

Question 6

What are private costs?

Answer 6

Negative effects of an economic transaction to the individuals or firms involved

Question 7

What are external costs?

Answer 7

Negative spillover effects of an economic transaction to third parties for which no compensation is paid

Question 8

What are social costs?

Answer 8

Social costs = private costs + external costs

Negative effects of an economic transaction to society

Question 9

What are private benefits?

Answer 9

Positive effects of an economic transaction to the individuals or firms involved

Question 10

What are external benefits?

Answer 10

Positive side effects of an economy transaction experienced by third parties for which no money is paid beneficiary

Question 11

What are social benefits?

Answer 11

Social benefits = private benefits + external benefits

Positive effects of an economic transaction to society

Question 12

Define negative externalities

Answer 12

External costs to a third party

Question 13

Examples (negative externalities)

Answer 13

• transport/driving: emissions, congestion
• dumping/rubbish: space, fees
• smoking: intake of toxic particles
• excessive alcohol consumption: antisocial behaviour, cost to NHS

Question 14

What does the deadweight welfare loss represent?

Answer 14

It represents the loss to society caused by ignoring externalities

Question 15

What does the deadweight welfare gain represent?

Answer 15

Potential welfare gain:
It represents the gain to society that is lost by ignoring externalities

Question 16

What are private goods?

Answer 16

Goods that are provided by the private sector, and are excludable and rivalry (e.g. food, clothes, electronics)

Question 17

What are club goods?

Answer 17

Goods that are excludable and non-rivalry (e.g. online subscriptions, memberships)

Question 18

What are common goods?

Answer 18

Goods that are non-excludable and rivalry (e.g. grazing sheep, tuna in the ocean, trees in the rainforest)

Question 19

What are public goods?

Answer 19

Goods that are non-excludable and non-rivalry, as well as non-rejectable (e.g. national defence, street lighting. asteroid defence)

Question 20

What is (non-)rivalry?

Answer 20

Whether or not the consumption of the good/service prevents someone else from using it (has a limited quantity/has no fixed quantity)

Question 21

What is (non-)excludability?

Answer 21

Whether or not you can stop someone from using the good/service (has a price/does not have a price)

Question 22

What is the tragedy of the commons?

Answer 22

The idea that people will overuse a common resource due to everyone acting in their own best self-interest, without considering the actions of others/cost to society, leading to a depletion/degradation of the resource (happens with common goods)

Question 23

What is the free-rider problem?

Answer 23

Once a public good is provided, it is impossible to stop someone from consuming/benefitting from it, even if they haven’t paid for/contributed toward it, which is why firms aren’t willing to provide public goods as consumers aren’t willing to pay for them (resulting in government intervention)

Question 24

Examples of the free-rider problem

Answer 24

• street cleaning
• flood defences
• street lighting
• public parks
• recreational facilities
• positive externalities: education/heathcare

Question 25

What are quasi-public goods?

Answer 25

Goods that are non-excludable and non-rivalry but can be made excludable and rivalry (via tolls/congestion/taking up space)

Question 26

Examples of quasi-public goods

Answer 26

Non-pure public goods:
- roads
- outdoor gyms/facilities
- beaches
- parks
- public transport
- libraries

Question 27

What is symmetric information?

Answer 27

When all participants in a market have equal and perfect knowledge

Question 28

What is asymmetric information?

Answer 28

When one party in an economic transaction knows more than the other (usually sellers)

Question 29

Consequences of asymmetric information

Answer 29

1. Moral hazard: when someone else suffers the consequence from the risk you take (e.g. insurance)
2. Adverse selection: when consumers think we’re buying something but we get something else
3. Underconsumption of merit goods and overconsumption of demerit goods (misallocation of resources)