3.8 Limitations of Markets

Question 1

Externality

Answer 1

An effect of an economic activity on a third pNegatarty

Question 2

Negative externality

Answer 2

A harmful effect of an economic activity on a third party. Also known as an external cost.

Question 3

Positive externality

Answer 3

A positive effect of an economic activity on a 3rd party. Also known as an external benefit

Question 4

Example of negative externality

Answer 4

Air pollution from smoking

Question 5

Example of positive externality

Answer 5

Less air pollution from someone riding their bike instead of taking a car

Question 6

What are 5 things the government can do to prevent positive and negative externalities

Answer 6

• Taxation
• Subsidies
• State provision
• Legislation and regulation
• Information provision

Question 7

How does taxation correct positive and negative externalities

Answer 7

Higher taxes means
Less profit for firms
So in a competitive market they would supply less
Vice versa

Question 8

What are costs and benefits of correcting externalities with taxes

Answer 8

Cost: Indirect taxes affect people with lower incomes more as it is a larger proportion of their money.
Can lead to unofficial markets- black markets

Benefit: Provide revenue to the government so that they can spend more on preventing negative externalities like information provision

Question 9

How do Subsidies correct positive and negative externalities

Answer 9

Subsidy given
Investment can be made to increase efficiency of production process
COP lowers
More good produced

Question 10

What are costs and benefits of correcting externalities with subsidies

Answer 10

Cost: Could have used money elsewhere
Benefit: Consumption of that good will rise

Question 11

What is state provision

Answer 11

Goods and services provided directly by the government

Question 12

How does state provision correct positive and negative externalities

Answer 12

As the government provides it free of charge at the point of consumption
People don’t have to worry if the price is too high
So they can always access it (healthcare)

Question 13

What are costs and benefits of correcting externalities with state provision

Answer 13

Costs: Demand will often exceed supply
Pressure will be put on the government to spend on some areaas and there will always be opportunity cost
Demand may increase at a faster rate than supply- Ageing population
Benefits: consumers who are able to gain access will benefit greatly, but this may not be everyone all of the time

Question 14

Legislation

Answer 14

Laws to control the way people and organisations behave

Question 15

Regulation

Answer 15

Rules, Directives or government orders to control the way people and organisations behave

Question 16

How does legislation and regulation correct positive and negative externalities

Answer 16

Legislation to ban certain products can be put in place
This means that the supply for the product is 0
This makes the consumption 0 and the externality is gone

Question 17

What are costs and benefits of correcting externalities with legislation and regulation

Answer 17

Costs: Dangers of unofficial markets- black markets
Have to spend money policing that
Opportunity cost of money spent elsewhere

Question 18

Information provision

Answer 18

The government provides information to enocurage people and organisations to change their behaviour

Question 19

How does information provision correct positive and negative externalities

Answer 19

If the government can educate people about the harms of demerit goods
Through things like education programmes or adverts
Demand will decrease
Reducing the quantity and the negative externality

Question 20

What are costs and benefits of correcting externalities with information provision

Answer 20

Benefits: Cheaper than subsidising alternatives
Costs: Not always effective as some people are addicted to demerit goods like smoking