2.8 Market Failure + gvt intervention Flashcards
market failure
Market failure occurs when the allocation of resources by the market is inefficient, leading to welfare loss. This happens when the market fails to produce the optimal quantity of goods and services, where marginal social benefits (MSB) are equal to marginal social costs (MSC). As a result, social or community surplus (the sum of consumer and producer surplus) is not maximized, leading to either underproduction or overproduction. The government often intervenes to correct these inefficiencies and restore allocative efficiency.
Causes of Market Failure:
* Externalities: When the production or consumption of a good affects third parties who are not involved in the transaction (e.g., pollution from a factory affecting the surrounding community).
* Public Goods: goods that are non-excludable and non-rivalrous (like national defense or street lighting), which the market may fail to provide efficiently.
* Monopoly Power: When a single seller controls the market and can set prices above the competitive level, reducing social welfare.
externalities
ms seghers: Externalities exist when the consumption or production of a good impacts others who are not the producer or consumer of that particular good or service. These are the side effects carried by third parties, known as the external cost or external benefits. Externalities can be either negative and result in external costs or positive and result in external benefits.
chat: Costs or benefits of an economic activity that affect third parties who are not directly involved in the transaction. Externalities can be positive (benefits, e.g., education improving society) or negative (costs, e.g., pollution harming public health). They lead to market failure if not corrected by government intervention.
marginal benefit
seghers: The extra or additional benefit enjoyed by consumers that arises from consuming one more unit of output.
chat: The additional satisfaction or utility gained from consuming one more unit of a good or service. It typically decreases as more units are consumed, reflecting diminishing marginal utility.
marginal cost
seghers: The extra or additional costs of producing one more unit of output
chat: the additional cost incurred from producing one more unit of a good or service. It often increases as production expands, reflecting the law of diminishing returns.
marginal social benefit (MSB)
seghers: The extra or additional benefit/utility to society of consuming an additional unit of output, including both the private benefit and the external benefit.
chat: The additional benefit to society from consuming one more unit of a good or service, including both private benefits and any external benefits. MSB reflects the total gain to society, not just the individual consumer.
marginal social cost (MSC)
seghers: The extra or additional cost to society of producing an additional unit of output, including both the private cost and the external costs.
chat: The additional cost to society of producing one more unit of a good or service, including both private costs and any external costs. MSC accounts for the full impact of production on society, such as environmental harm or resource depletion.
Negative externalities of consumption
Negative efects / costs suffered by a third party whose interests are not considered when a good or service is consumed, so the third party is therefore not compensated.
The harmful effects on third parties or society resulting from the consumption of a good or service. These external costs are not reflected in the market price and may include issues like pollution, second-hand smoke, or increased healthcare costs due to excessive alcohol consumption.
negative externalities of production
Negative effects / costs suffered by a third party whose interests are not considered when a good or service is produced, so the third party is therefore not compensated.
The harmful effects on third parties or society caused by the production of a good or service. These external costs are not borne by the producer and may include environmental damage, pollution, or health issues related to industrial activities.
positive externalities of consumption
The beneficial effects / benefits that are enjoyed by third parties whose interests are not accounted for when a good or service is consumed, therefore they do not pay for the benefits they receive.
The beneficial effects on third parties or society resulting from the consumption of a good or service. These external benefits are not reflected in the market price and may include benefits like improved public health from vaccinations or increased education leading to a more informed society.
positive externalties of production
The beneficial effects that are enjoyed by third parties whose interests are not accounted for when a good or service is produced, therefore they do not pay for the benefits they receive.
The beneficial effects on third parties or society resulting from the production of a good or service. These external benefits are not reflected in the market price and may include things like technological advancements, improved infrastructure, or environmental benefits from sustainable production practices.
welfare loss
The loss of economic efficiency that occurs when the allocation of resources is not optimal, often due to market failures such as externalities. It represents the lost benefits to society (loss of social surplus) where the marginal social benefit does not equal the marginal social cost.
socially optimum output
This occurs where there is allocative efficiency, or where the marginal social cost (MSC) of producing a good is equal to the marginal social benefit (MSB) of the good to society.
The level of production or consumption where the marginal social cost (MSC) equals the marginal social benefit (MSB), resulting in the most efficient allocation of resources for society. At this point, the net welfare is maximized, and there are no externalities causing market failure.
allocative efficiency
Achieved when just the right amount of goods and services are produced from society’s point of view so that scarce resources are allocated in the best possible way. It is achieved when, for the last unit produced, price (P) is equal to marginal cost (MC), or more generally, if marginal social benefit (MSB) is equal to marginal social cost (MSC).
demerit goods
Goods or services that not only harm the individuals who consume these but also society at large, and that tend to be overconsumed in a free market and so resources are overprovided resulting in market failure. Demerit goods create negative consumption externalities.
Cause of market failure
External cost: MPB > MSB
Negative externality of consumption
Overconsumption
Government intervention needed to correct
examples: tobacco, alcohol, and fast food.
merit goods
Goods or services considered to be beneficial for people that are under consumed in a free market and so resources are underallocated resulting in market failure. Merit goods create positive consumption externalities.
Cause of market failure
External benet: MSB > MPB
Positive externality of consumption
Underconsumption
Government intervention needed to correct
examples education, healthcare, and public libraries.
types of government intervention
1) price controls
* max. price
* min. price
2) policies to impact supply
* indirect taxes
* producer subsidies
3) comand and control regulation and legislation
4) direct provision
government provision / direct provision
the government is responsible for the production of a particular good/service. government revenues are needed to finance the production of the good. publicly provided services like education and health care or facilities like parks, motorways, sewage systems to reduce market failure.
public good
two main characteristics of a public good:
1) non-rivalry: the consumption by one individual does not reduce the ability of others to use them.
2) non-excludable: its impossible or very costly for producers to charge a price and thus exlucde whoever is not willing or able to pay for it from enjoying it.
Because public goods are often underprovided by the market, governments typically step in to provide these goods, as the free-rider problem occurs when individuals benefit from the good without contributing to its cost.
Public goods often require government intervention to ensure that they are provided efficiently and are not overused or underfunded.
examples: public parks, national defense, air quality.
command and control regulation and legislation
direct rules and laws set by a government or authority to limit/govern/ban an actviity by a firm often accrding to environmental or social reasons.
market failure vs equilibrium
Market Failure represents a situation where the market is not functioning efficiently, often requiring government intervention to correct the problem.
Equilibrium represents a balanced and efficient state in a competitive market where the forces of supply and demand are aligned.
equilibrium
Market equilibrium is the state where supply equals demand at a particular price. At this point, there is no pressure for the price or quantity to change unless there is an external shift in supply or demand.
marginal private cost (MPC)
The additional cost incurred by producers for producing one more unit of a good or service, considering only the private costs of production (e.g., labor, materials). It does not account for any external costs imposed on society.
Marginal Private Cost (MPC) is essentially represented by the supply curve in a perfectly competitive market.
marginal private benefit (MPB)
The additional benefit received by consumers from consuming one more unit of a good or service, considering only the private benefits to the individual. It does not include any external benefits that may accrue to society.
Marginal Private Benefit (MPB) is essentially represented by the demand curve in a market.
Common pool resources
A diverse group of natural resources that are non-excludable, but their use is rivalrous, for example, fisheries.
Natural or man-made resources that are shared by multiple individuals or groups, where consumption by one person reduces the availability for others. These resources are non-excludable but rivalrous, meaning it’s difficult to prevent others from using them, and overuse can lead to depletion or degradation. Examples include fisheries, forests, and clean water.
