1.8 The market mechanism, Market failure & Government intervention

Question 1

What is the Price Mechanism?

Answer 1

• 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

Question 2

What is Market Failure and how does it occur?

Answer 2

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)

Question 3

What is Government Intervention and what are the aims?

Answer 3

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

Question 4

What are the advantages of the Price Mechanism?

Answer 4

• 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

Question 5

What are the disadvantages of the Price Mechanism?

Answer 5

• 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

Question 6

What is complete Market Failure?

Answer 6

when there is no market whatsoever
g/s will not be supplied as firms will not recieve revenue

e.g. street lighting

Question 7

What is Partial Market Failure?

Answer 7

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

Question 8

Why would there be a misallocation of resources?

Answer 8

• Public goods
• Externalities
• Merit/demerit goods
• Monopoly power
• Inequality in the distribution of wealth + income
• other market imperfections

Question 9

What are Public goods?

Answer 9

Non-rival
- when consumption doesn’t reduce amount available for others

Non-excludable
- once provided, its impossible to stop others from using them

Question 10

What are Pure public goods?

Answer 10

impossible to exclude someone from consuming, if they are unilling to pay

e.g. air

Question 11

What is the free-rider problem and what can it lead to?

Answer 11

someone who benefits from a g/s without paying for it
leads to market failure as there is no incentive to supply
gov. intervenes

Question 12

What are Private goods?

Answer 12

Rival
- consumption reduces amount available for others

Excludable
- once provided, its possible to stop others from using them

Question 13

What are Quasi-public goods?

Answer 13

similar to public good but has some element of a private good

e.g. restricting access to a park or beach

Question 14

How can technical change lead to markets providing private goods?

Answer 14

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

Question 15

What is the tragedy of the commons?

Answer 15

when individuals maximise private benefits at the expense of society
can lead to market failure

Question 16

What are Negative externalities?

Answer 16

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

Question 17

What are Positive externalities?

Answer 17

when social benefit > private benefit

e.g. firm invests into training workforce
social benefit = pool of better trained workers
private benefit = well-trained employees

Question 18

Why do externalities lead to market failure?

Answer 18

economic units only consider the private costs and benefits
not the social

Question 19

What are the 4 types of externalities?

Answer 19

• Negative production
• positive production
• Negative consumption
• positive consumption

Question 20

Graphs for different externalities

Answer 20

see notes 1.8.4

Question 21

What are Merit goods?

draw a graph for a merit good

Answer 21

• beneficial for society
• however, under-provided by market
• therefore gov. intervenes to increase supply

e.g. education, healthcare
1.8.5 - notes

Question 22

What is a Demerit good?

draw a graph for a demerit good

Answer 22

• 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

Question 23

What is imperfect information?

what can it lead to?

Answer 23

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

Question 24

What is Provision of information?

Answer 24

ensures that economic units can maximise decisions when consuming and producing g/s

Question 25

How is a Monopoly an example of market failure?

Answer 25

• only one firm in industry
• provides with market power > high prices, supernormal profits
• leads to misallocation of resources and allocative inefficiency

Question 26

What is factor immobility?

Answer 26

when its difficult for FoP to be put to alternative use
- results in misallocation of resources

Question 27

What is the immobility of labour?

result of?
due to?

Answer 27

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

Question 28

What is occupational immobility?

Answer 28

when workers are not equipped for different types of jobs

miner cannot be an accountant

Question 29

What is capital immobility?

Answer 29

a result of:

rapid technological change
- costs to update capital equipment

structural change in economy
- industry changes > so will capital equipment needed

Question 30

What is land immobility?

Answer 30

a result of:
climate conditions > cannot produce grapes in UK
subsidies in EU so farmers and fishermen continue to produce

Question 31

How does factor immobility lead to market failure?

Answer 31

if FoP are immobile the market finds it difficult to clear when there is a change in demand and supply

Question 32

How does governments influence the allocation of resources?

(gov intervention)

Answer 32

Public expenditure
Taxation + subsidies
Regualtion

Question 33

What are the effects of an indirect tax?

and draw diagram

Answer 33

increases cost to supply

Question 34

Draw diagram for indirect tax with inelastic demand + elastic demand

and same for inelastic + elastic supply

Answer 34

1.8.9

Question 35

What are the positives of indirect taxation?

Answer 35

• increases cost of production
• internalises externalities
• solves overconsumption/production
• allocative efficiency
• gov. revenue

Question 36

What are the negative of indirect taxation?

Answer 36

• price inelastic demand
• setting tax at right level
• potential job losses
• black markets forming

Question 37

What are the positives of a subsidy?

Answer 37

• lowers cost of production
• prices falls, quantity demaned increases
• solves underconsumption/production
• welfare gain

Question 38

What are the negatives of a subsidy?

Answer 38

• costs
• setting at right level
• firms misusing subsidy
• price inelastic demand

Question 39

What is a minimum price?

and draw diagram (P min)

Answer 39

leads to excess supply (between Q1 and Q2)
as firms wish to supply more at a higher price

Question 40

What are the positives of a minimum price?

Answer 40

• raises price
• discourages demand
• externality is internalised
• overconsumption/production solves

Question 41

What are the negatives of a minimum price?

Answer 41

• price inelastic demand
• black markets
• set at right level?