2.4 Market Failure Flashcards
Allocative Efficiency (when)
Resources are allocated efficiently when it is NOT possible to benefit one person without making someone else worse off
Technical (productive) efficiency
when firms pursue the least cost method of production. Where firms produce at minimum average cost
Allocative (economic) efficiency
where resources are allocated into their best use. Where price equals marginal cost.
Marginal Cost
is the cost to society of all the scarce resources in producing a good, including risk taking for profit
Market Failure
is the situation in which the free market leads to under-allocation or over-allocation of resources to a specific good or service, leading to an overproduction, under production, over consumption, or under consumption
Pareto optimality
“socially efficent” Market is an equilibrium with no external influences/effects
What is the socially optimal output?
where MSC = MSB, where social/community surplus is maximised and where allocative efficiency occurs.
Non - rivalrous public goods
many users can consume the goods at the same time
Non - exclusive public goods
no one can be excluded from its use
What can a government do to intervene in response to a need for public goods?
direct provision
contracting out to the private sector
Common access resources (def)
the ‘gifts of nature’ over which there is no private ownership and therefore no effective means of regulating use of the resourceE
Examples of common access resources
fish in the sea
trees in a forest
common pastureland
the air we breathe
What is the tragedy of the commons
lack of ownership creates an incentive for potential users to exploit them to the fullest extent possible, so as to extract as much benefit as possible before other extract and exploit the resource.
Privatization
assigning private ownership over a resource to create an incentive amongst private owners to protect and manage it sustainably.
Government management
control over access and use it to limit it to sustainable usage
Tradeable permits
issuing permits to private users to allow a certain amount of extraction in a period of time to limit exploitation and maintain sustainable usage
Merit good
refers to a private good that has positive externalities associated with its consumption
Demerit good
refers to a private good that has negative externalities associated with its consumption
Asymmetric Information in reality
decisions are based on incomplete information
one has more information than the other
Government solution to asymmetric information
legislation
regulation
provision of information
Opportunistic behavior
this is when one party takes advantage of the fact that the other party lacks information. It reults in adverse selection or moral hazard.
Adverse selection
A form of opportunistic behavior that refers to the undesired decisions or results of decisiosn when buyers and sellers have access to different information. It distorts price and quantity.
Moral Hazard
A situation where a party protected from risk behaves differently than if they were fully exposed to the risk. This can impose costs on the other party that has less information. thsi means the consequences of one’s actions are borne by society as a whole or by a third party, rather than by the individual himself.
Private responses to asymmetric information
signalling and screening
signalling
a strategy undertaken by the party with more/superior information to maximize own return/utility
Screening
A strategy underatken by parties with less/inferior information to maximize their own return/utility. this means screening out biased, inaccurate or misleading information.
Abuse of monopoly power in imperfect competition
monopoly: we assume that all firms aim to maximize profit. Therefore in the absence of competitions, monopolists will have incentive to restrict output and push up price.
Welfare loss: community surplus is not maximized
Government actions for imperfect competition
regulation
nationalization
trade liberalization
regulatory bodies
Wealth
the stock of economic goods and services owned and measured at a particular point in time
Income
the flow of economic payments
Government solutions to income issues
Taxation system (NOTE - altering the progressive system is the solution to income inequality) - progressive taxation, proportionate taxation, regressive taxation
Transfer payments
progressive taxation
where the rate of tax increases the higher the income
proportionate taxation
where the rate of tax is proportionate to income
regressive taxation (e.g. indirect tax)
where the rate of tax decreases the higher the income
transfer payments
when the government transfers income from one group of the population to another through taxation and benefits
Factors of production in a perfect market
resources move easily between uses for higher FOP usage
FOP in reality
shortages
time lags
lack of factor substitutes
especially lack of labour mobility
Government solutions to FOP
retraining schemes
move to workers/workers to work
Short termism in a perfect market
effects are immediate, or there is not effect
short termism in reality
short term decisions with long term problems
private sector - resource and sustainability
public sector - elections, demerit goods
Externalities
goods produced external to the price mechanism
refers to a spillover in production or consumption that arises in social costs or benefits from a firm or individual undertaking an economic activity.
Negative externality of production
refers to a spillover in production that arises in social costs when a firm undertakes an economic activity.
Solutions to neg. ext. of prod.
taxation
fines
legislation/government regulations
tradeable permits (allocating property rights)
neg. ext. of prod. solution: taxation shift?
shift supply curve inwards which will increase price and decrease output. because a firm is producing less of the good, less spillovers of production will be produced as well, and the existence of the externality will decrease or disappear. Welfare loss is reduced or eliminated.
