2.9, 2.10, 2.11 Markets

Question 1

What are the three types of economy and how are they defined?

Answer 1

1. Market (less government intervention),
2. Mixed (neutral-ish)
3. Planned (more government intervention)

Question 2

What are the characteristics of a market economy?

Answer 2

• Individuals can own property
• Freedom of choice
• Self-interest (to maximise profits and income)
• Limited government intervention
• Price used to allocate resources

Question 3

What are the advantages of a market economy?

Answer 3

• Profits motivates entrepreneurs/workers
• Greater variety of goods/services
• Competition creates better quality, lower prices & innovation

Question 4

What are the disadvantages of a market economy?

Answer 4

• Income inequality
• Workers get exploited
• Resource depletion
• Environmental damage ignored
• Monopolies –> consumers/supply chains exploited

Question 5

Define market failure

Answer 5

When there is a lack of efficiency in the allocation of resource from the point of view of society

Question 6

Give examples of market failure

Answer 6

• Over-provision of demerit goods (e.g. cigarettes)
• Under-provision of merit goods (e.g. schools)
• Lack of public goods
• Factor immobility
• Inequality
• Environmental damage

Question 7

What is an externality?

Answer 7

An impact on a third party not involved in the interaction between a buyer & seller (can be positive or negative)

Question 8

What is an external cost?

Answer 8

Damage not factored into the transaction (e.g litter, pollution)

Question 9

What is the social cost of a transaction?

Answer 9

Social cost = private cost + external cost

Question 10

What is a private cost?

Answer 10

What a consumer/producer/government pays for a good/service

Question 11

What are external/social benefits?

Answer 11

Positive externalities (benefits not factored into the transaction)

Question 12

How do governments deal with market failure by over-provision of demerit goods?

Answer 12

Regulate goods by raising prices or limiting quantity

Question 13

How do governments deal with market failure by under-provision of merit goods?

Answer 13

Subsidise goods to lower prices or increase quantity

Question 14

How do governments deal with market failure by lack of public goods?

Answer 14

Provide public goods themselves (parks, national defence, libraries, etc)

Question 15

How do governments deal with market failure by abuse of monopoly power?

Answer 15

Intervene to ensure healthy competition and sufficient provision of goods/services

Question 16

How do governments deal with market failure by factor immobility?

Answer 16

Implement programs to reduce factor immobility (education, training, etc)

Question 17

Give the four main methods governments use to address market failure.

Answer 17

Indirect taxation, subsidies, maximum prices and minimum prices

Question 18

Explain the advantages and disadvantages of maximum prices as a way to address market failure

Answer 18

Advantages:
- Some consumers benefit (lower prices)
- Can stabilise markets in the short term
Disadvantages:
- Some consumers unable to purchase due to shortage (excess demand), may turn to illegal markets
- Can result in inefficient allocation of scarce resources

Question 19

Explain the advantages and disadvantages of minimum prices as a way to address market failure

Answer 19

Advantages:
- Agriculture: producers benefit (higher price) & government buys surplus supply
- Demerit: output falls
- Producers lower output to match QD, reduces external costs

Disadvantages:
- Costs government to buy surplus supply, famers may become over-dependant
- Output falls –> unemployment

Question 20

Explain the advantages and disadvantages of indirect taxes as a way to address market failure

Answer 20

Advantages:
- Reduces output of demerit goods
- Raises government revenue

Disadvantages:
- Effectiveness depends on PED (inelastic –> consumers still buy)
- Can create illegal markets (for lower prices)
- Output falls –> unemployment

Question 21

Explain the advantages and disadvantages of producer subsidies as a way to address market failure

Answer 21

Advantages:
- Targeted to help specific industries
- Lowers prices/increases demand for merit goods

Disadvantages:
- Distorts allocation of resources - excess supply
- Opportunity cost for government, better use for money?
- Prone to political pressure (subsidies to oil/gas companies)

Question 22

Give five reasons why a government may intervene in an economy.

Answer 22

1. Correct market failure
2. Earn government revenue
3. Promote equity (reduce rich/poor opportunity gap
4. Support firms
5. Support poorer households (redistribute income)