3.1.5 The market mechanism, market failure and government intervention in markets Flashcards
What is the price mechanism?
Changes in supply and demand of a good/service leads to a change in its price and quantity bought or sold
What does the price mechanism do?
The way in which the basic economic problem of scarcity is resolved in a market economy.
Allocates goods/services in an impersonal way as prices will change until equilibrium is reached so that supply = demand.
What are the 3 functions of the price mechanism?
(1) signal - changes in price show changes in supply/demand which is a signal to producers and consumers
(2) Incentive - Higher prices encourage increased production and sales through high profit
(3) Ration - scarce resources used allocatively efficient.
What are the advantages of the price mechanism?
Resources are used allocatively efficient to satisfy consumer wants and needs.
Not costly to regulate it
Prices are kept to a minimum as resources are being used efficiently
What are the disadvantages of the price mechanism?
Inequality in wealth and income
under provision of merit costs and over provision of demerit goods - not at the socially optimum level
public goods won’t be produced
What is consumer surplus and producer surplus?
Consumer surplus: . It’s the difference between the price that a consumer is willing to pay for a good/ service and the price they actually pay. Area below demand curve and above equilibrium price line.
Producer surplus: Difference between the price that a producer is willing to supply a good/ service and the price that they actually receive for it. Area above supply curve and below equilibrium price line.
Define market failure
When the price mechanism fails to allocate scarce resources efficiently.
Not allocated to the best interests of society - allocatively inefficient
Only the PC and PB are considered not the EC or EB
What is meant by a misallocation of resources?
Scarce resources are used allocatively inefficient. It is caused by an information gap - so more demerit goods and goods with negative externalities are consumed
What is the difference between complete and partial market failure?
Complete: Missing market e.g. national defense
Partial: A market exists but contributes to resource misallocation by wrong pricing or quantity supplied e.g. healthcare
Define positive externality
benefits to a third party by the action/ decision of others. They are usually under consumed / under produced
Define externalities
Cost or benefit a third party receives from an economic transaction outside of the market mechanism.
They exist when there is a divergence between private and social costs and benefits
Define negative externality
A cost imposed onto a third party by the action/ decision of others. Only the PC and PB are considered resulting in overconsumption / overproduction
What is a social optimum?
True benefit is taken into consideration. MSC =MSB at p2,q2 where society wants us to be at
What is a positive/negative externality in consumption?
Consumers impose a benefit/cost onto others when they consume goods/services
What is a positive/negative externality in production?
When producers impose a benefit/cost onto others through their production processes
Define merit good
Has more benefits then their consumers realize due to information failure and there is an underconsumption / underproduction
SB > PB
depends on value judgment
Define de merit goods
Consumption is more harmful than consumers realize due to information failure there is overconsumption / overproduction
SC > PC
depends on value judgment
What is a subsidy?
A payment from the government to a producer which lowers the cost of production which is used to encourage them to produce more so there is encouragement of consumption of merit goods
What are some disadvantages of using subsidies?
(1) depends on if its an elastic good/service
(2) government may need to increase taxes to fund the subsidy - cost
(3) Opportunity cost - NHS, Education
(4) May not be used rightly - increase profits
What is an indirect tax?
Taxes on specific goods to increase cost of production for producers so that they’re less willing and able to supply and can discourage consumption of demerit goods
What are some disadvantages of using tax?
(1) Depends on elasticity of the good/service
(2) Inequitable - risk for people on low incomes
(3) Size of tax
Define regulations
Government set laws to ban consumers from consuming goods (illegal)
What are some disadvantages of using regulations?
(1) firms/ consumers may not comply with the law
(2) Difficult to police - costs
(3) Heavy fines - act as a disincentive to break the rule - size of the punishment
define maximum price
The government set a maximum price where the consumption or production of a good is encouraged - set below the free market price
define minimum price
The government set a minimum price where the consumption or production of a good is discouraged - set above the free market price
Define pure public goods that are non - rival and non - excludable
Non - rival: One person benefitting from the good doesn’t stop others also benefitting e.g. flood defense scheme - 0 MC
Non - excludable: People cannot be stopped from consuming the good even if they haven’t paid for it e.g. benefits from the services of the armed forces
What is the difference between a public and private good? (pure public goods)
Public good: Goods consumed collectively cannot be rejected or excluded
Private good: Excludable and exhibit rivalry - choice
What is a quasi-public good?
When a public good may take on some of the characteristics of a private good e.g. tolls
What is the significance of technological change to public goods?
The invention of digital technology has meant that channels can be encrypted so people have to pay for certain channels
What is the free rider problem?
Once a public good is provided, it’s impossible to stop someone from benefitting from it, even if they haven’t paid for it. e.g. a firm providing street cleaning
What is meant by the ‘state provision of public goods’?
The government providing public goods which are underprovided in the free market such as education and healthcare. Merit goods become more accessible for consumption
What are the 2 types of indirect tax?
(1) Specific: fixed amount charged per unit of a particular good regardless of its price
(2) Ad valorem: Charged as a proportion of the price of a good
Define government failure
Government intervention can lead to resources being misallocated and a net welfare loss (unintended consequence of intervening to correct market failure)
Give examples of government intervention causing market distortions
(1) Income taxes can act as a disincentive to working hard
(2) Price fixing - min / max price leads to distortions of price signals.
Firms may overproduce when they will receive guaranteed min price
(3) Subsidies may encourage firms to be inefficient or e.g. subsidies for public transport may not increase demand that much as it’s viewed as an inferior good. You may prefer to go by car for convenience and privacy
