2.9 - 2.11 Market economic system, Market failure, Mixed economic system

Question 1

What is an economic system?

Answer 1

The way of organising the production and distribution of goods and services in an economy.

Question 2

What is a command market?

Answer 2

Resources are allocated by the state and the market mechanism only lays a small part linked to the public sector

Question 2

What is a free market?

Answer 2

Majority of resources are allocated through markets rather than through the government planning private sector.

Question 3

What is a mixed market?

Answer 3

Some resources are allocated by the state and the market mechanism allocates some resources.

Question 4

What are the characteristics of a free market?

Answer 4

Property ownership - Individuals have the right to purchase the factors of production

Freedom of choice - Individuals are free to start their own business. Firms are free to decide what they are going to produce

Self interest - Entrepreneurs maximise profits. Workers maximise wages. Consumers maximise their well - being

Limited Government intervention - A free market economy no government intervention. Most free market economies low level of intervention, usually in the form of taxation, provision, defence, health care and education.

Price mechanism - Changes in prices allocate scarce resources. Rising prices indicate a shortage of resources and falling prices indicate a surplus of resources.

Question 5

What is allocate efficiency?

Answer 5

Occours when resources are allocated in a way that maximises consumers satisfaction. Meaning firms produce the products that consumers demand in the right quantities.

Question 6

What is productivity efficient?

Answer 6

When products are produced at the lowest possible cost and firms are making full use of resources.

Question 7

What is Dynamically efficiently?

Answer 7

Efficiency occurring over time as a result of investment.

Question 8

What is price mechanism?

Answer 8

The means by which decisions of consumers and businesses interact to determine the efficient allocation of resources.

Question 9

What are the advantages of a free market economic system?

Answer 9

No government intervention.
Economy is boosted increased production of product
More efficient use of scare resources
Profits income and wealth are unlimited resulting in better standards of living
Competition encourages innovation because they exist for product produce for exactly what for consumers demand
Competition leads to lower prices of goods and services
Competition leads to better quality of goods and services.
Greater variety of goods and services.

Question 10

What are the disadvantages of a free market economic system?

Answer 10

Demerit goods are over produced this is because the free market doesn’t take social cost into account social cost are greater than private cost can lead to inefficient allocation of resources.

Negative externalities private firms are not concerned about the social cost created by production of some goods which has a negative impact on some third parties

Public goods like streetlights and flood defensives and underprovided due to the lack of profit incentive causes complete market failure

Merit good like education and healthcare are unprovided creating partial market failure

Inequalities services like NHS and welfare payments underprovided.

Monopolies develop as firms increase market power through mergers.

Product qualitiy can fall as firms lower quality standards to increase profit workers become exploited

Question 11

What is the private sector?

Answer 11

Buisness organisations which are owned by share holders or individuals.

Question 12

What is the public sector?

Answer 12

Government run services and state owned buisnesses.

Question 13

What is nationalisation?

Answer 13

When the government take control of an industry previously owned by private firms

Question 14

What is privatisation

Answer 14

When a government owned buisness operation or property becomes owned by a private non government party

Question 15

What are the key features of command market?

Answer 15

The price mechanism has no active role all key economic decisions made by the government

Government control control everything rather than private enterprises to ensure the fair distribution of goods and services motivated by equality and welfare.

Central planners set prices, control production levels and limit or prohibit competition within the private sector

Government officals set national economic priorities, including how to generate economic growth ad ow to allocate resources and how to distribute the output.

Question 16

What is a command market?

Answer 16

Where government or other central bodies control the allocation of resources.

Question 17

What are the advantages of a command economic system?

Answer 17

Everyone is guaranteed a job supplies and resources are distributed out equally and there is more merit goods.

Production for the common good the government tailors its production to necessities merit goods and public goods are produce without regard to profit or lose.

Reduces inequality - because society maximises social welfare over profit, this enables the government to overcome inequality and market failure.

Low levels of unemployment the government controls the means of production in a command market therefore determines who works there and for how much.

Question 18

What are the disadvantages of a command economic system?

Answer 18

Lack of efficiency from the labour force
Less profit is made from the enterprises
Consumers are restricted on what they can buy and sell everyone earns the same amount of money. Excess supply

Inefficiency lack of profit incentive results in a inefficient production process as the government feels no pressure from competitors or price concerned consumers to cut cost or streamline operations

Asymmetric information - Central planners make economic decisions, Firms lack perfect information on what decisions to make and therefore shortage of necessities may develop

Question 19

What is Market failure?

Answer 19

When the free market and price mechanism fail to allocate resource efficiently

Question 20

What are demerit goods?

Answer 20

Goods which consumers do not fully appreciate how harmful they are

Question 21

What are externalities’?

Answer 21

The third party effects arising from the production and consumption of goods and services for which no appropriate compensation is payed.

Question 22

What are the 2 cost of production?

Answer 22

Private cost : Cost borne by those directly involved in the production of a good

External cost : Cost borne not only by those directly involved in the production of a good but also society as a whole. Social cost greater than private cost

Question 23

What are merit goods?

Answer 23

Goods which consumers do not fully appreciate how beneficial they are.

Question 24

What are the benefits of consumption?

Answer 24

Private benefits: Benefits borne to those directly involved in a consumption of a good

External benefits : benefits borne not only by those directly involved in the consumption of a good but also society as a whole

Question 25

What are the consequences of market failure?

Answer 25

Demerit goods:
They are over-provided in a market and their consumption often creates external costs
Governments often have to regulate these goods in such a way that they
raise the prices and/or limit the quantities consumed

Merit goods:
They are under-provided in a market & their consumption generates both private and/or external benefits
Governments often have to subsidise these goods in order to lower the price and/or increase the quantities consumed

Public goods:
Non-excludability refers to the inability of private firms to exclude certain customers from using their products. In effect, the price mechanism cannot be used to exclude customers e.g. street lighting
Non-rivalry refers to the inability of the product to be used up, so there is no competitive rivalry in consumption to drive up prices and generate profits for firms
Therefore, governments will often provide these beneficial goods themselves, and so they are called public goods

Monopoly power:
The outcome is that goods/services are purposely under-provided in order to raise prices and profits
Governments often intervene to ensure that there is healthy competition in markets & sufficient provision of goods/services

Factor immobility:
Factor immobility results an inefficient allocation of resources in a market (usually under-provision)
Governments often implement programs to reduce the factor immobility in order to raise production & output

Question 26

What are public goods?

Answer 26

Public goods are beneficial to society but would be under-provided by a free market as there is little opportunity for sellers to make profits from providing these goods/services as they are non-excludable and non-rivalrous in consumption
Good examples include national defence, parks, libraries and lighthouses

Question 27

How does a free market develop monopolies?

Answer 27

The development of monopoly markets is a natural outcome of a market system
Firms seek to eliminate competition by buying out competitors & increasing their ownership of factors of production
With less competition, firms can raise prices, reduce the choice available to consumers, or limit the supply

Question 28

What is factor immobility?

Answer 28

Factor immobility occurs when it is difficult for factors of production to move or switch between different uses/locations
The two main types of factor immobility are the geographical & occupational immobility of labour

Question 29

What is information failure?

Answer 29

When buyers and sellers don’t have the information necessary to make a rational decision.

Question 30

What is Asymmetric information?

Answer 30

When one economic agent has more information about a certain good or services than another economic agent.

Question 31

What is Symmetric information?

Answer 31

Where all economic agents have identical information

Question 32

When does market failure occour?

Answer 32

Market Failure occurs when free market activity results in a less than optimum allocation of resources from the point of view of society

Question 33

Wat are the main methods the government use to address market failure?

Answer 33

Four of the most commonly used methods to address market failure in markets are indirect taxation, subsidies, maximum prices, & minimum prices

Question 34

How do the government use maximum prices to address market failure?

Answer 34

A maximum price is set by the government below the existing free market equilibrium price & sellers cannot legally sell the good/service at a higher price

Governments will often use maximum prices in order to help consumers.

Question 35

What are the advantages and disadvantages of using maximum prices?

Answer 35

Advantages: Some consumers benefit as they purchase at lower prices
They can stabilise markets in the short-term during periods of intense disruption

Disadvantages : Some consumers are unable to purchase due to the shortage
The unmet demand usually encourages the creation of illegal markets (black/grey markets) as desperate buyers turn to illegal bidding
Maximum prices distort market forces & therefore can result in an inefficient allocation of scarce resources

Question 36

What is minimum prices and how do th government use it to address market failure?

Answer 36

A minimum price is set by the government above the existing free market equilibrium price & sellers cannot legally sell the good/service at a lower price

Governments will often use minimum prices in order to help producers or to decrease consumption of a demerit good e.g. alcohol

Question 37

What are the advantages and disadvantages of using minimum prices?

Answer 37

Advantages:
In agricultural markets, producers benefit as they receive a higher price, Gov purchase excess supply

When used in demerit markets, output falls, Gov dont purchase excess supply

Producers usually lower their output in the market to match the QD at the minimum price & this helps to reduce the external costs

Disadvantages:
it costs the government to purchase the excess supply & an opportunity cost is involved

Farmers may become over-dependent on the Government’s help

Producers lower output which may result in an increase in unemployment in the industry

Question 38

What is indirect taxation and how do the government use it to address market failure?

Answer 38

An indirect tax is paid on the consumption of goods/services
It is only paid if consumers make a purchase
It is usually levied by the government on demerit goods to reduce the quantity demanded (QD) and/or to raise government revenue
Government revenue is used to fund government provision of goods/services e.g education

Indirect taxes are levied by the government on producers. This is why the supply curve shifts

Producers and consumers each pay a share (incidence) of the tax

Question 39

What are the advantages and disadvantages of indirect taxes?

Answer 39

Advantages:
Reduces the quantity demanded of demerit goods
Raises revenue for government programs

Disadvantages:
The effectiveness of the tax in reducing the use of demerit goods depends on the price elasticity of demand (PED)
Many consumers who purchase products that are price inelastic in demand will continue to do so
It may help create illegal markets as consumers seek to avoid paying the taxes
Producers may be forced to lay off some workers as output falls due to the higher prices

Question 40

What is producer subsidies and how is it used to address market failure?

Answer 40

A producer subsidy is a per unit amount of money given to a firm by the government
To increase production
To increase the provision of a merit good

The way a subsidy is shared between producers & consumers is determined by the price elasticity of demand (PED) of the product
Producers keep some of the subsidy & pass the rest on to the consumers in the form of lower prices

Question 41

What are the advantages and disadvantages of producer subsidies?

Answer 41

Advantages: Can be targeted to helping specific industries
Lowers prices & increases demand for merit goods
Helps to change destructive consumer behaviour over a longer period of time

Disadvantages: Distorts the allocation of resources in markets
There is an opportunity cost associated with the government expenditure
Subsidies are prone to political pressure & lobbying by powerful business interests

Question 42

What is a mixed market system?

Answer 42

Some resources are allocated by the state and the market mechanism allows some resources.

Question 43

What are the characteristics of a mixed market?

Answer 43

Individuals, firms & the government own factors of production & distribute goods/services
In reality, almost every country in the world operates as a mixed economic system
Some countries have more government intervention than others
The higher the level of government intervention, the more the economy will lean towards operating like a planned economy

Question 44

What are the reasons why the government intervene in mixed market systems?

Answer 44

To correct market failure: in many markets there is a less than optimal allocation of resources from society’s point of view
In maximising their self-interest, firms & individuals will not self-correct this misallocation of resources & there is a role for the government
Governments often achieve this by influencing the level of production or consumption

Earn government revenue: governments need money to provide essential services, public and merit goods
Revenue is raised through intervention such as taxation, privatisation, sale of licenses (e.g. 5G licenses), & the sale of goods/services

Promote equity: to reduce the opportunity gap between the rich & poor

Support firms: in a global economy, governments choose to support key industries so as to help them remain competitive

Support poorer households: poverty has multiple impacts on both the individual & the economy
Intervention seeks to redistribute income (tax the rich & give to the poor) so as to reduce the impact of poverty