3.8 Limitations of markets Flashcards
Market failure definition
If a free market leads to an equilibrium, quantity above or below the socially efficient level a market is said to fail, this is because resources aren’t allocated to maximise social efficiency.
negative externality definition
Costs imposed on third parties as a result of economic activity.
positive externality definition
Benefits enjoyed by a third party as a result of economic activity.
Consumption externality definition
They arise when consumers don’t take into account the extreme costs or benefits to 3rd parties of their consumption decision
Production externality definition
Arise when a producer doesn’t take into account the costs or benefits to 3rd parties as a result of their production decisions.
Demerit goods definition
are products that would be over-produced and over-consumed in a free market
Merit goods definition
products that would be underproduced and under-consumed in a free market
Solution to market failures
1) taxes (indirect) - these will reduce supply and increase the price of a goods and so reduce the quantity traded.
2) subsidies - will increase supply and reduce the price of a good and increase quantity traded.
3) state provision - the government provides some merit goods and products that have significant positive externalities at a small charge
4) Information provision - the government often produces information to discourage consumption of demerit goods to increase the quantity of merit goods traded and/or to reduce quantity of demerit goods traded.
5) laws and regulations - may restrict or ban economic activity that leads to negative externalities.
Evaluation of indirect taxes
The extent to which a tax will reduce quantity traded of a good depends on the PED.
it may also lead to affects on the distribution of incomes as they can affect people in lower income groups more significantly as they are taking a higher proportion of their incomes.
Policy may benefit one objective and not another.
Taxes can lead to unofficial markets forming.
If it leads to higher prices than in other countries, smuggling is likely to take place.
The opportunity cost of policing is that the money could be spent elsewhere.
Evaluation of subsidies
Opportunity cost of the policy is that there may be other competing areas that would benefit from GOV spending.
Benefits and costs if regulation
+ ve:
Legally binding - producers/consumers have to adjust behaviour at risk of prosecution
Have an immediate affect and can lead to long term changes in behaviour
Raises revenue from fines
-ve:
May create shadow or illegal markets
Danger of non-compliance.
Depends on how well it’s policed and enforced
Cost of implementation, inspection and enforcement may be very high to governments, firms and consumers (opportunity cost)
Benefits and costs of state provision
+ve:
Improve the efficiency of resource allocation (increasing consumption/production of merit goods with positive and negative externalities)
May benefit the less well of - reducing inequality
More socially sustainable - as state provision may be seen as ‘fair’ if allocated based on need - instead of price
-ve:
May be expensive and impose an opportunity cost in terms of other govt, spending/higher taxes
Lack of market incentives may reduce efficiency
May create excess demand since supply is fixed and since there is no ‘rationing’ goods and services, some other method may have to be found
Benefits and costs of provision of information
+ve:
Reduces over/under production and consumption arising from lack of information
consumers can make choices based on more complete information and uncertainty for firms is reduced
-ve:
May be expensive and imposes opportunity cost
May not be effective if it doesn’t reach target audience or is ignored.
