3.8 Limitations Of Markets

Question 1

Externalities definition

Answer 1

A cost or benefit to a ‘third party’ outside the economic activity being undertaken

Question 2

Negative externalities definition

Answer 2

The costs imposed on third parties as a result of economic activity

Question 3

Positive externalities definition

Answer 3

Benefits enjoyed by third parties as a result of economic activity

Question 4

Demerit goods definition

Answer 4

Products that would be over-produced and over-consumed in a free market, due to information failure, may result in negative externalities

Question 5

Merit goods definition

Answer 5

Products that would be underproduced and under-consumed in a free market, due to information failure, may result in positive externalities

Question 6

Possible solution to market failure

Answer 6

• taxes, will reduce supply and increase the price and decreases the quantity traded
• subsidies, increase supply, reduce the price and increase the quantity traded
• state provision, government provides some merit goods at no/low charge to increase quantity traded
• law/legislation and regulation, may restrict or ban economic activity that leads to negative externalities(ban on smoking in public places)
• information provision, tries to change the behaviour of economic agents, especially consumers, through providing consumers with information about the good or service

Question 7

Indirect taxes chain of reasoning and eval

Answer 7

• increase in indirect tax , decreases supply and decreases quantity traded
• increase income inequality, higher proportion of income for those who earn less
  Depends on:
• PED inelastic PED will be less effective at reducing quantity demanded
• illegal markets forming, policing these may be costly, therefore creating negative externalities
• size of increase

Question 8

Subsidies consequences and eval

Answer 8

Subsidies reduce costs of production for firms, this increases there willingness and ability to supply, this is reflected in a shift to the right in supply, decreasing costs for consumers and increasing quantity traded
Depends on:
- size of the subsidy
- PED more elastic will increase consumption more
- opportunity costs for the government