2.9 information failure

Question 1

what is a demerit good ?

Answer 1

Demerit goods are goods that would be over-porduced and over-consumed in a free market, due to an associated information failure, where buyers over-value the private benefit/utility of consuming the product

Question 2

what is information failure ?

Answer 2

individuals may over/under-estimate the private benefit of consuming the product, due to imperfect information

Question 3

what is the effect of demerit goods ?

Answer 3

demerit goods can also result in negative externalities, the overall effect is that the marginal private benefit (MPB) which reflects market demand is greater than the marginal social benefit (MSB) at the market determined output. This means due to the information failure, social welfare is not maximised since Q1 > Q*

Question 4

what is an example chain of reasoning for a demerit good ?

Answer 4

Question 5

what is a merit good ?

Answer 5

merit goods are goods that would be under-produced and under-consumed in a free market, due to an associated information failure

Question 6

what is the effect of merit goods ?

Answer 6

merit goods often exhibit positive externalities, the overall effect is MSB > MPB at the market determined output, therefore the wider impact on society is that social welfare is not maximised, due to the information failure

Question 7

what are the 4 types of information failure ?

Answer 7

1. misleading or incomplete information e.g misleading claims in advertising
2. uncertainty of information e.g future benefits with pension products
3. misunderstanding e.g scientific research
4. complex informationm e.g sales with complex contracts

Question 8

how does information failure lead to market failure ?

merit and demerit goods chain of reasoning

Answer 8

Question 9

what is asymmetric information ?

Answer 9

Asymmetric information occurs when one agent in an economic transaction has better information about a G/S than another economic agent

e.g sellers and buyers of cosmetic surgery, sellers have more information

Question 10

what is adverse selection ?

Answer 10

adverse selection occurs as a consequence of asymmetric information when an economic agent with superiror information uses it to their advantage, the unequal information distorts the market and leads to market failure

e.g sellers of second hand goods may have better information about the true quality of the good, therfore buyers or more relectant to buy 2nd hand goods, many buyers withdraw from the market due to lack of information about the product and the seller using asymmetric information to their advantage

Question 11

what is moral hazard ?

Answer 11

the possibility that an economic agent will take more risk since another economic agent will bear some or all of the burden of their risk

e.g health insurance, buyers of health insurance may take more risk since the healthcare provider bears the risk

Question 12

what are some possible solutions for information failure ?

Answer 12

• regulation - such as compulsory provision of information
• wareanties/guarantees
• legal protection of consumer rights and minimum advertising standards