1.3.1 - Types of market failure

Question 1

Define market failure

Answer 1

Market failure occurs when the market fails to allocate scarce resources efficiently, causing a loss in social welfare

Question 2

State three types of market failure

Answer 2

o externalities
o under-provision of public goods
o information gaps

Question 3

Describe externalities

Answer 3

CONSUMPTION AND PRODUCTION of some goods/services provides COSTS OR BENEFITS to economic agents that were not involved in the transaction

Question 4

Describe underprovision of public goods

Answer 4

some goods/services would be underprovided if provision was left entirely to private sector e.g healthcare

“Public goods are non-rivalry and non-excludable,
meaning they are underprovided by the private sector due to the free-rider problem.
The market is unable to ensure enough of these goods are provided.”

Question 5

Describe information gaps

Answer 5

Some markets have information problems for consumers and or producers which results in under or over consumption of the product

• Therefore, economic agents do not always make rational decisions and so resources are not allocated to maximise welfare.

Question 6

What is the effect of externalities

Answer 6

This leads to the over or under-production of goods, meaning resources aren’t allocated efficiently

Question 7

Micro definition of market failure

Answer 7

TOO MUCH OR TOO LITTLE of a good is produced and/or consu,er compared to the socially OPTIMAL LEVEL OF OUTPUT, or when the price mechanism leads to INEFFICIENT allocation of resources.