3) Market Failure (Introduction) - MMT Flashcards
in a free market economy, such as the UK, resources are normally allocated via the…
price mechanism, ie demand and supply
what happens when there is a change in the market conditions?
then prices will adjust, both demand and supply will also adjust, in a short period of time it is expected that equilibrium will be restored in the market
the price mechanism acts as a kind of…
‘invisible hand’ to ensure that the market will operate efficiently, an excess demand or excess supply will only be temporary, change in prices will soon eliminate these excesses
what percentage of goods and services in our economy does the market work well, and what percentage of goods and services in our economy does the market not work properly?
- 75% works well
- 25% doesn’t work well (known as market failure)
definition: when does market failure exist?
market failure exists when the competitive outcome produced by the operation of the free market is not the best outcome for society
definition: when do externalities exist?
externalities exist when the production or consumption of a good or service causes an impact for an unrelated 3rd party
what are the 4 possible types of externality?
- negative externality of production
- negative externality of consumption
- a positive externality of production
- a positive externality of consumption
when does a negative externality of production occur?
this occurs when the process of producing a good or service creates a negative consequence for individuals or groups outside the business
what is an example of a negative externality of production?
a factory making a good might cause harmful pollution in a local area
when does a negative externality of consumption occur?
this occurs when the action of consuming a good or service creates a negative consequence for individuals or groups not consuming it
what is an example of a negative externality of consumption?
an individual consuming too much alcohol may cause damage or harm to others
when does a positive externality of production occur?
this occurs when the process of producing a good or service creates a positive consequence for individuals or groups outside the business
when does a positive externality of consumption occur?
this occurs when the action of consuming a good or service creates a positive consequence for individuals or groups not consuming it
what is an example of a positive externality of consumption?
eg individuals choosing to cycle rather than drive to work may help reduce traffic congestion in the area
what is an example of a positive externality of production?
eg building a new school may improve facilities and education for the local area
externalities generate…
external costs or benefits , ie the consumption or production leads to cost or benefit to an external (unrelated) individual or group
the consumption or production also generates…
a private cost or benefit to the consumer or producer
explain the externalities caused by an alcohol consumer
- private cost to the alcohol consumer might be £50
- the external cost may be more than that due to damage/harm
we must add private cost (or benefit) with the external cost (or benefit) to find social cost (benefit)
what is the social cost or benefit of consumption or production?
it is the total impact on society, this is how we measure the impact of the decision or process
what is a summary of market failure
the free market is perfect for the production /consumption of most goods/services. Sometimes however it is inefficient, as it only considers the private cost or benefit to the business or consumer involved and does not consider the needs of society as a whole
what is the definition of market failure?
a situation where the allocation of resources is inefficient. Leading to marginal social cost being greater than marginal social benefit
what is marginal social cost?
the additional cost to society of producing one extra unit of a good
what is marginal social benefit?
the additional benefit that society gains from consuming an extra unit of a good
what is the definition of “externalities”?
a cost or a benefit that is external to the market transaction, thus not reflected in the market price
