1.8 The market mechanism, Market failure & Government intervention Flashcards
What is the Price Mechanism?
- buyers and seller in a free market
- resources move to where there is short supply relative to demand, and away from where there is least demand
What is Market Failure and how does it occur?
inefficient allocation of resources in a free market
- monopoly (high price, low output)
- negative externalities (over-consumed)
- public goods (usually not provided in a free market)
What is Government Intervention and what are the aims?
gov. intervene to try and overcome market failure
may also seek to improve distribution of resources (equality)
Aims:
- stabalise prices
- discourage demerit goods / encourage merit
- Avoid excessive prices for g/s with important social welfare
What are the advantages of the Price Mechanism?
- indicates what g/s to supply to satisfy consumers (allocative efficiency)
- e.g. if D increases, resources will be allocated to that product, vice versa
Competitive markets
- firms lower costs
- productive efficiency
What are the disadvantages of the Price Mechanism?
- creates inequality
- public goods, ignored by private firms
Info assymetry
- monopoly power, leads to consumers being exploited
High priced luxury goods produced at the expense of neccessities > misallocation of resources
if firms cannot adapt to trends, they will go out of business. > unemployment > impacts society
What is complete Market Failure?
when there is no market whatsoever
g/s will not be supplied as firms will not recieve revenue
e.g. street lighting
What is Partial Market Failure?
when a market exists but there is a misallocation of resources
g/s will be supplied but at the wrong amounts
e.g. merit/demerit goods
Why would there be a misallocation of resources?
- Public goods
- Externalities
- Merit/demerit goods
- Monopoly power
- Inequality in the distribution of wealth + income
- other market imperfections
What are Public goods?
Non-rival
- when consumption doesn’t reduce amount available for others
Non-excludable
- once provided, its impossible to stop others from using them
What are Pure public goods?
impossible to exclude someone from consuming, if they are unilling to pay
e.g. air
What is the free-rider problem and what can it lead to?
someone who benefits from a g/s without paying for it
leads to market failure as there is no incentive to supply
gov. intervenes
What are Private goods?
Rival
- consumption reduces amount available for others
Excludable
- once provided, its possible to stop others from using them
What are Quasi-public goods?
similar to public good but has some element of a private good
e.g. restricting access to a park or beach
How can technical change lead to markets providing private goods?
Intellectual property rights (IPR)
- patents, copyright, etc. goods become protected and therefore excludable
Monitoring and control systems
- restricting use by monitoring usage
- e.g. congestion charge
What is the tragedy of the commons?
when individuals maximise private benefits at the expense of society
can lead to market failure
What are Negative externalities?
when social cost > private cost
e.g. firm creates air pollution by using a factory
social cost = pollution > poor air quality
private cost = cost of making good to firm
What are Positive externalities?
when social benefit > private benefit
e.g. firm invests into training workforce
social benefit = pool of better trained workers
private benefit = well-trained employees
Why do externalities lead to market failure?
economic units only consider the private costs and benefits
not the social
What are the 4 types of externalities?
- Negative production
- positive production
- Negative consumption
- positive consumption
Graphs for different externalities
see notes 1.8.4
What are Merit goods?
draw a graph for a merit good
- beneficial for society
- however, under-provided by market
- therefore gov. intervenes to increase supply
e.g. education, healthcare
1.8.5 - notes
What is a Demerit good?
draw a graph for a demerit good
- over-provided by market
- negative externality
- over consumption leads to market failure
- gov. intervenes to reduce supply
e.g. drugs, cigarettes
1.8.5 notes
What is imperfect information?
what can it lead to?
type of market failure
- do not have perfect information
- asymmetric knowledge
leads to under-provision of merit goods and over-provision of demerit goods
as its difficult for producer and consumers to make decisions regarding price, quantity, quantity
What is Provision of information?
ensures that economic units can maximise decisions when consuming and producing g/s
How is a Monopoly an example of market failure?
- only one firm in industry
- provides with market power > high prices, supernormal profits
- leads to misallocation of resources and allocative inefficiency
What is factor immobility?
when its difficult for FoP to be put to alternative use
- results in misallocation of resources
What is the immobility of labour?
result of?
due to?
a result of:
geographical immobilty - workers find it difficult to move from one region to another
due to:
cost of moving
imperfect info e.g. not aware of jobs
moving away from family
What is occupational immobility?
when workers are not equipped for different types of jobs
miner cannot be an accountant
What is capital immobility?
a result of:
rapid technological change
- costs to update capital equipment
structural change in economy
- industry changes > so will capital equipment needed
What is land immobility?
a result of:
climate conditions > cannot produce grapes in UK
subsidies in EU so farmers and fishermen continue to produce
How does factor immobility lead to market failure?
if FoP are immobile the market finds it difficult to clear when there is a change in demand and supply
How does governments influence the allocation of resources?
(gov intervention)
Public expenditure
Taxation + subsidies
Regualtion
What are the effects of an indirect tax?
and draw diagram
increases cost to supply
Draw diagram for indirect tax with inelastic demand + elastic demand
and same for inelastic + elastic supply
1.8.9
What are the positives of indirect taxation?
- increases cost of production
- internalises externalities
- solves overconsumption/production
- allocative efficiency
- gov. revenue
What are the negative of indirect taxation?
- price inelastic demand
- setting tax at right level
- potential job losses
- black markets forming
What are the positives of a subsidy?
- lowers cost of production
- prices falls, quantity demaned increases
- solves underconsumption/production
- welfare gain
What are the negatives of a subsidy?
- costs
- setting at right level
- firms misusing subsidy
- price inelastic demand
What is a minimum price?
and draw diagram (P min)
leads to excess supply (between Q1 and Q2)
as firms wish to supply more at a higher price
What are the positives of a minimum price?
- raises price
- discourages demand
- externality is internalised
- overconsumption/production solves
What are the negatives of a minimum price?
- price inelastic demand
- black markets
- set at right level?
