1.3.1 Types of market failure

Question 1

Market failure

Answer 1

The price mechanism fails to allocate resources efficiently.

Question 2

Types of market failure: Externalities

Answer 2

A cost/benefit a third party receives from an economic transaction outside of the price mechanism. This leads to the over or underproduction of goods, meaning resources aren’t allocated efficiently e.g. cigarettes (negative) education (positive)

Question 3

Types of market failure:
Under-provision of public goods

Answer 3

Public goods (non-rivalry and non-excludable) are under-provided due to the free-rider problem, where it is possible for people to consume a good without paying for it once it has been provided, this means firms are unable to collect revenue from consumers e.g. streetlights.

Question 4

Types of market failure:
Information gaps

Answer 4

When one party in a transaction has more or better information than the other party. So economic agents do not always make rational decisions and so resources are not allocated to maximise welfare e.g. second hand cars (or) antiques.