1.3.1: Types of Market Failure

Question 1

When does market failure occur?

Answer 1

• Occurs when the market failure fails to allocate scare resources efficiently, causing a loss in social welfare loss

Question 2

What are the three main types of market failure?

Answer 2

• Externalities
• Under-provision
• Information Gaps

Question 3

What is an externality?

Answer 3

• An externality is the cost or benefit a third party receives from an economic transaction
• it is the spillover effect of the production or consumption of a good or service.

Question 4

What are public goods?

Answer 4

• Public goods are goods which are non-excludable and rival as well as underprovided in a free market.

Question 5

What is the free rider problem?

Answer 5

• The burden on a shared resource that is created by its use or overuse by people who aren’t paying their fair share for it, or who aren’t paying anything at all.

Question 6

What are information gaps?

Answer 6

• Information gaps are situations where there is a discrepancy between what individuals know and what they need to know
• Firms are assumed to have perfect information on their cost and revenue curves and governments are assumed to know the full cost and benefits of each decision, though this isn’t the case
• Information gaps cause economic agents to not make rational decisions, causing the misallocation of resources