3) Market Failure (Introduction) - MMT

Question 1

in a free market economy, such as the UK, resources are normally allocated via the…

Answer 1

price mechanism, ie demand and supply

Question 2

what happens when there is a change in the market conditions?

Answer 2

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

Question 3

the price mechanism acts as a kind of…

Answer 3

‘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

Question 4

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?

Answer 4

• 75% works well
• 25% doesn’t work well (known as market failure)

Question 5

definition: when does market failure exist?

Answer 5

market failure exists when the competitive outcome produced by the operation of the free market is not the best outcome for society

Question 6

definition: when do externalities exist?

Answer 6

externalities exist when the production or consumption of a good or service causes an impact for an unrelated 3rd party

Question 7

what are the 4 possible types of externality?

Answer 7

• negative externality of production
• negative externality of consumption
• a positive externality of production
• a positive externality of consumption

Question 8

when does a negative externality of production occur?

Answer 8

this occurs when the process of producing a good or service creates a negative consequence for individuals or groups outside the business

Question 9

what is an example of a negative externality of production?

Answer 9

a factory making a good might cause harmful pollution in a local area

Question 10

when does a negative externality of consumption occur?

Answer 10

this occurs when the action of consuming a good or service creates a negative consequence for individuals or groups not consuming it

Question 11

what is an example of a negative externality of consumption?

Answer 11

an individual consuming too much alcohol may cause damage or harm to others

Question 12

when does a positive externality of production occur?

Answer 12

this occurs when the process of producing a good or service creates a positive consequence for individuals or groups outside the business

Question 13

when does a positive externality of consumption occur?

Answer 13

this occurs when the action of consuming a good or service creates a positive consequence for individuals or groups not consuming it

Question 14

what is an example of a positive externality of consumption?

Answer 14

eg individuals choosing to cycle rather than drive to work may help reduce traffic congestion in the area

Question 15

what is an example of a positive externality of production?

Answer 15

eg building a new school may improve facilities and education for the local area

Question 16

externalities generate…

Answer 16

external costs or benefits , ie the consumption or production leads to cost or benefit to an external (unrelated) individual or group

Question 17

the consumption or production also generates…

Answer 17

a private cost or benefit to the consumer or producer

Question 18

explain the externalities caused by an alcohol consumer

Answer 18

• 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)

Question 19

what is the social cost or benefit of consumption or production?

Answer 19

it is the total impact on society, this is how we measure the impact of the decision or process

Question 20

what is a summary of market failure

Answer 20

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

Question 21

what is the definition of market failure?

Answer 21

a situation where the allocation of resources is inefficient. Leading to marginal social cost being greater than marginal social benefit

Question 22

what is marginal social cost?

Answer 22

the additional cost to society of producing one extra unit of a good

Question 23

what is marginal social benefit?

Answer 23

the additional benefit that society gains from consuming an extra unit of a good

Question 24

what is the definition of “externalities”?

Answer 24

a cost or a benefit that is external to the market transaction, thus not reflected in the market price