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economics hl > 2.8-2.9 market failure > Flashcards

2.8-2.9 market failure Flashcards

the free market is failing

1
Q

essay prompt: analyse demerit goods as a market failure

how to answer this essay?

A
  • define “demerit goods”, “market failure” & “negative consumption externality”
  • why MPB > MSB
    • explain with hypothetical example
      • e.g. impact to society bc of drinking
      • ignorance
  • explain overallocation of resources
    • Qm > Qopt
    • Pm > Popt
  • explain deadweight loss
    • at Qm (MSC > MSB)
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2
Q

what as the assumptions of allocative efficiency? [3]

A
  • markets are free
  • without market failure
  • perfectly competitive
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2
Q

6 causes of market failure

and brief reasons for why they occur

A
  • negative externalities (self-interest)
  • positive externalities (self-interest)
  • demerit goods (information failure)
  • merit goods (information failure)
  • public goods (free rider & non-profitable)
  • common pool resources (self-interest → tragedy of the commons)
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2
Q

market failure definiton

A

failure of the market to allocate resources efficiently

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2
Q

underallocation of resources

A

not enough resources allocated to production of a good

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2
Q

overallocation of resources

A

too many resources allocated to production of a good

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3
Q

externalities

A

action of consumers or producers give rise to negative or positive side-effects on those not part of the transaction (third-party)

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3
Q

what does market failure evaluate? ____ vs ______

A

expectation from society vs desire from market

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4
Q

Private Benefits (PB) =

A

Consumer’s benefits upon consumption

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5
Q

Social Benefits (SB)

A

PB + External Benefits

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6
Q

Private Costs (PC) =

A

Producer’s costs of production

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7
Q

Social Costs (SC) =

A

PC + External Costs

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8
Q

what are positive external costs?

A

e.g. pollution

things that BRING UP the cost

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9
Q

what are negative external costs?

A

things that are GOOD FOR SOCIETY

e.g. recycling

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9
Q

What is the private benefit of taking medication / vaccination?

A

make you healthy, give you immunity

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10
Q

Is there going to be an positive / negative external benefit from taking medication?

A

other people won’t get sick

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10
Q

PB > / < SB for medication?

A

SB > PB, ignore external benefit

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11
Q

What is the private cost of producing beef?

A
  • food for the cows
  • rent for the land
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12
Q

Is there going to be positive / negative external cost from producing meat?

A
  • NEGATIVE
  • methane from cows
  • global warming
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13
Q

Cows for meat production

PC > / < SC

A

SC > PC, ignore external cost

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14
Q

Marginal private benefits (MPB)

A

benefits to consumers of consuming one more unit

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15
Q

Marginal social benefit (MSB)

A

benefits to society of consuming one more unit

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16
Q

Marginal private costs (MPC)

A

costs to producers of consuming one more unit

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17
Q

MPC = MPB –> ?

A

market equilibrium

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17
Q

assumptions in a free and competitive market for marginal + surplus + Q

A

In a free and competitive market:

  • It is assumed that there will be no external costs and benefits, (MPC = MSC & MPB = MSB)
  • Social welfare is at its maximum level, (CS + PS)
  • At market price, Qd= Qs, no surplus / shortage)
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18
Q

Marginal social costs (MSC)

A

costs to society of consuming one more unit

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18
Q

Market failure will happen if ___?

A

there is a difference between the social and market expectation

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19
Q

MSC = MSB –> ?

A

social optimum = allocative efficiency

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20
Q

for negative production externalities, is MSC or MPC higher?

A

MSC

MSC > MPC

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20
Q

describe negative production externalities in terms of MSC/MSB/MPC/MPB

A
  • Social optimal outcome is MSB = MSC
  • Free market outcome is MPB = MPC
  • Divergence between Private Costs and Social Costs (MSC > MPC)
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21
Q

in negative production externality, due to self interest, do you think the producer would produce more / less quantity of cars than the society wanted?

A

MORE

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22
Q

when does welfare loss occur?

A

when MSC>MSB or MSC<MSB

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23
Q

what happens to the allocation of resources when there is a negative production externality

A

overallocation of resources

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24
Q

what are the market based policies to correct negative production externalities

A

Pigouvian taxes (indirect taxes)

tradable permits

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25
Q

what are Pigouvian taxes?

A

indirect taxes to correct negative externality

26
Q

what are the 3 common methods to correct negative production externalities

A

market based interventions: pigouvian taxes, tradable permits

government regulations

education

27
Q

how would you tax the air pollution by car factories?

A

tax on emission level

28
Q

why would taxing production output of car factories not be effective?

A
  • would not be incentivised to become cleaner in production → will be taxed either way
  • tax on the emission level
29
Q

explain the short run and long run impacts of carbon tax

A
  • SHORT RUN
    • cost of production increase (MPC will shift left)
  • LONG RUN
    • incentives for producers to use less polluting or non-polluting energy sources
    • incentives for producers to be more efficient and invest in cleaner technologies
30
Q

explain how tradable permits work

A
  • government gives firms “permits to pollute”
  • permits can be traded on the free market
    • can sell permit to others / can buy permit from others to pollute more
31
Q

explain how tradable permits are effective

A
  • supply of permits is fixed (perfectly inelastic)
  • if firms need to increase the output level, the demand for permits will increase
  • price of buying permits increases
  • what happens to factory A and B when the price of permits increases → increase in cost of production
32
Q

explain the short run and long run impacts of tradable permits

A

SHORT RUN

  • the higher cost from trade permits will increase the MPC

LONG RUN

  • it gives incentives to producers to switch to less polluting resources → MSC decreased
    • why such incentives?
      • no need to buy excessive permits
      • able to sell the remaining permits for higher profit
33
Q

advantages of using market based policies to solve the negative production externalities?

A
  • External costs can be internalised (more taxes have to be paid by producers & consumers if output increases) → burden goes back to transaction parties
  • Taxes on pollutants emitted provide incentives to firms for using less pollution production
34
Q

disadvantages of using taxes (market based policies) to solve the negative production externalities?

A

Taxes

  • Technical difficulties
    • what production methods produce pollutants?
    • what pollutants are harmful?
    • what is the value of the harm (externalities)?
    • how much should be charged on the tax?
  • Some firms with high cost of reducing production may not try to reduce emission but pay the tax
35
Q

disadvantages of using tradable permits (market based policies) to solve the negative production externalities?

A

All technical difficulties faced by designing taxes

  • The amount of maximum acceptable level for pollutants
  • How to distribute the permits to polluting firms in a fair way
36
Q

give examples of how legislation and regulation can be used to correct negative production externalities

A
  • Require firms to install technologies reducing emissions
  • Setting maximum level of pollutants permitted
  • Limiting the output by the polluting firms
37
Q

advantages of government regulation

A
  • It can be implemented easily compared to market-based policies
  • Regulations force polluting firms to comply and reduce pollution levels (taxes may not)
  • The practical difficulties are too great to implement market-based solutions
38
Q

disadvantages of government regulation

A
  • No incentive for firms to use less polluting resources (Unable to lower the size of the externality)
  • Problems with enforcement (costs?)
  • It may suffer from similar limitations (e.g technical difficulties) as the market-based policies
    – What pollutants should be regulated
    – Amount of the pollutants should be regulated
39
Q

advantages of using education to correct negative production externalities

A

Producers’ production and revenue are based on the consumer demand and preferences

40
Q

disadvantages of using education to correct negative production externalities

A
  • Opportunity costs
  • It may take a long time to achieve the effect
  • People may not be responsive (no one cares) to problems of a general nature (e.g. green house gas emission)
40
Q

define demerit goods

A

goods which create a negative consumption externality, and are overprovided in the market

40
Q

for MSC/MSB/MPC/MPB, which of these does negative consumption externalities affect?

A

MPB > MSB

40
Q

what is negative consumption externality?

A

-ve External benefit created by consumers (when consuming a good)

41
Q

examples of demerit goods

A

gambling, cigarettes, drugs, alcohol

42
Q

why might demerit goods be overprovided? why do consumers still demand demerit goods?

A
  • Consumer ignorance about its negative effects
  • Consumers may not be aware / care about the harmful effects upon others from their actions
43
Q

the welfare loss for negative consumption externalities is when….?

A

MSB < MSC

44
Q

what are the types of government intervention for negative consumption externalities?

A
  • government regulation
  • advertising and education
  • market based policies (e.g. indirect (excise) tax)
45
Q

advantages of government intervention in correcting negative consumption externalities

A

Indirect tax
- Internalise the externality
- Incentives for consumers to change their consumption patterns

Advertising and Education
- Much simpler

Regulation
- Direct enforcement

46
Q

disadvantages of government intervention in correcting negative consumption externalities

A

Indirect tax
- Design of tax
- Who and what is affected
- Value of the external costs
- How much should be taxed
- Some of the goods may have an inelastic demand

Advertising and Education
- Opportunity costs
- They may not be effective in reducing the negative externality
- It may only be effective in the long-run

Regulation
- Difficult for enforcement

47
Q

does positive consumption externality affect Marginal Costs or Marginal Benefits?

A

marginal benefits

48
Q

in positive consumption externality, is MSB larger or MPB larger

A

MSB > MPB

49
Q

examples of merit goods

A

education, insurance, healthcare service, recreational service

50
Q

define merit goods

A

goods/services which benefit consumers & society, but are underprovided by the market

51
Q

Why might vaccines be under-consumed in the market?

A
  • positive externalities
    - consumer ignorance of the benefits
    - unable to realise the greater benefits to the society
    • Low levels of income and poverty (unable to afford them)
52
Q

what are the types of intervention to correct positive consumption externality?

A
  • Legislation
  • Advertising
  • Direct Government Provision
  • Subsidy on the edu. providers
52
Q

evaluate government intervention for positive consumption externality

A

Government provision and subsidies
- opportunity cost
- size of external benefit
- difficult to achieve social optimum level
- not effective on its own

Legislation and advertising
- difficult to achieve social optimum level
- not effective on its own
- what will happen if government regulates schooling up to a minimum age without subsidies / direct provision or the other way around?
- combine policies (e.g. direct provision + legislation)
- may raise the price of goods

53
Q

what is positive production externality

A

positive benefits (external cost decrease) to third parties created by producers

54
Q

give examples of positive production externality

A
  • Polio vaccine (by Jonas Salk)
  • R&D into new technology: Atlas
    • robot, by Boston Dynamics

→ worker training

55
Q

what are the features of public goods?

A

non-rival & non-excludable

MUST have BOTH

55
Q

give examples of public goods

A
  • national defence
  • parks
  • statues/landmarks
  • public toilet
  • public libraries
  • roads/bridge → infrastructure
  • free TV channel
  • fire services
  • trash bins
56
Q

Types of intervention to correct positive production externality

A

Direct Government Provision
- R&D
- Government provided training

Subsidies
- Lower the costs of production (increase supply)

57
Q

explain the features of public goods

A

Non-rival
- consumption by one person does not reduce consumption by someone else
- rival e.g. 1 pair of jeans and 2 people
- non rival e.g. music performance/busking on the street

Non-excludable
- impossible to prevent people who have not paid for the good from having access to it
- excludable e.g. iphone bc you have to pay for it
- non-excludable e.g. fireworks

58
Q

the nature of public goods leads to what problem?

A

“free-rider problem” → the good will not be provided at all in the free market

59
Q

what is rival but non-excludable

A

free food for the homeless/in need, fishing

60
Q

what is excludable but non-rival

A

cable tv (you need to pay for the channels)

61
Q

How does the government correct the problem of public goods?

A

Government provision
-Opportunity cost (which good/service to provide? In what quantity?)
-Even more difficult to estimate MSB (no market price) than providing / subsidising on private goods.
-How can governments try to estimate?

62
Q

define common pool resources

A

resources not owned by anyone (as they are non-excludable), and therefore there is no price for use

63
Q

define tragedy of the commons

A

definition: common pool resources over-used by private individuals who enjoy the short term benefits, but ignore the long-term depletion of the resource

64
Q

why are common pool resources market failure?

A

When we overuse the air / river / sea / land / etc. for production without “paying” for them

consequences: Ozone depletion, destroying marine ecosystem, global climate change, excessive grazing, soil erosion

65
Q

define sustainable development

A

development that meets the needs of the present without compromising the ability of future generations to meet their own needs (pursue economic growth that does not deplete or degrade natural resources)

66
Q

explain tragedy of the commons using a diagram

A
  • The price at P1 is too low which encourages more consumption and thus more production

easier to explain with production side → negative production externality

  • e.g. overfishing, deforestation, exploiting fossil fuels
67
Q

what leads to tragedy of the commons?

A
  • Lack of private ownership leads to the tragedy of the commons
    • self interest → resource depletion
68
Q

define sustainability

A

ability of the environment and economy to be maintained or preserved over time

69
Q

what are the 2 components of sustainability?

A

1) Environment: environmental preservation (less environmental destruction)

2) Economy: preservation of humankind’s ability to provide goods and services to satisfy needs and wants into the future

70
Q

explain how collective self governance can be used to solve tragedy of the commons

A

Collective self governance to solve tragedy of the commons (Elinor Ostrom)

  • People do have the self-control to better use the common pool resources
    • government direct intervention may not be needed
    • within boundaries of areas (communities)
    • good communication with each other to establish norms e.g.
      • rules of using the resources
      • sanctions on violation
      • monitoring

video notes

  • state control and privatisation is not the only way → self governance
  • design of rules determines the success of the commons → design principles
  • success of rules is context dependent
71
Q

explain how international agreements can be used to solve tragedy of the commons & give examples

A
  • consequences from tragedy of the commons (e.g. global climate & ozone layer) always affect not only a single country
  • cooperation among different countries is crucial to control and prevent the problems from happening and worsening
  • Montreal Protocol
  • Kyoto Protocol
  • Paris Agreement
  • Convention on international trade in endangered species of wild fauna and flora
  • the protocol on water and health
72
Q

other than government intervention, what can be used to solve tragedy of the commons?

A

collective self governance

international agreements

economics hl (8 decks)

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