4.1.8 Market Mechanism, Market Failure and Government Intervention in Markets

Question 1

rationing function of price

Answer 1

scarce resources, price rises due to excess demand, the price then discourages demand and rations resources

Question 2

incentive function of price

Answer 2

encourages a change in behaviour from producer or consumer, a high price suggests firms should supply more as it is more profitable

Question 3

signalling function of price

Answer 3

price acts as a signal to consumers and new producers, shows where resources are needed, high price encourages firms to supply more, but also signals consumers to ration demand

Question 4

advantages of the price mechanism

Answer 4

• impersonal way of allocating resources
• consumer gains soveirgenty

Question 5

disadvantages of price mechanism

Answer 5

• does not consider inequality
• underprovision of merit and public goods

Question 6

when does market failure occur

Answer 6

when there’s a misallocation of resources

Question 7

misallocation of resources

Answer 7

when resources are not allocated to the best interests of society

Question 8

market failure- externality

Answer 8

cost or benefit a third party recieves from an economic transaction outside market mechanism

Question 9

market failure- underprovision of public goods

Answer 9

Public goods are non-excludable and non-rival, and they are underprovided in
a free market because of the free-rider problem.

Question 10

market failure- information gaps

Answer 10

It is assumed that consumers and producers have perfect information when
making economic decisions. However, this is rarely the case, and this
imperfect information leads to a misallocation of resources.

Question 11

market failure- monopolies

Answer 11

consumer has very little choice where to buy the goods and services
offered by a monopoly, they are often overcharged. This leads to the underconsumption of the good or service, and therefore there is a misallocation of
resources, since consumer needs and wants are not fully met.

Question 12

market failure- inequality

Answer 12

There is an unequitable distribution in income and wealth. This can lead to negative externalities, such as social unrest.

Question 13

complete market failure

Answer 13

occurs when there is a missing market. The market does not
supply the products at all.

Question 14

partial market failure

Answer 14

occurs when the market produces a good, but it is the wrong
quantity or the wrong price. Resources are misallocated where there is partial
market failure

Question 15

public goods

Answer 15

missing from the free market, but offer benefits to society eg street lights
non excludable
non rival

Question 16

non excludable

Answer 16

by consuming the good, someone else is not
prevented from consuming the good as well

Question 17

non rival

Answer 17

benefit other people get from the good does not diminish if more people
consume the good.

Question 18

free rider problem

Answer 18

people who do not pay for the good still receive benefits
from it, in the same way people who pay for the good do. This is why public
goods are underprovided by the private sector: they do not make a profit
from providing the good since consumers do not see a reason to pay for the
good, if they still receive the benefit without paying.

Question 19

why are public goods underprovided

Answer 19

it is difficult to measure the
value consumers get from public goods, so it is hard to put a price on the
good. Consumers will undervalue the benefit, so they can pay less, whilst
producers will overvalue, so they can charge more.

Question 20

private goods

Answer 20

rival
excludable

Question 21

quasi public goods

Answer 21

characteristics of both public and private
goods. They are partially provided by the free market. For example, roads are
semi-excludable, through tolls and they are semi-non-rival, because
consumers can benefit from the road whilst other consumers are using it
(unless it is rush hour).

Question 22

tragedy of the commons

Answer 22

The tragedy of the commons refers how individuals prioritise personal gain
over the well-being of society.
When resources are held in common, it means that no one owns the
resource, but everyone can access it.
For example, no one owns the air, but everyone can use it. This unlimited use
leads to the negative externality of air pollution. This is a market failure that
results from common access.

Question 23

externality

Answer 23

the cost or benefit a third party receives from an economic
transaction outside of the market mechanism. In other words, it is the spillover effect of the production or consumption of a good or service.

Question 24

negative externalities

Answer 24

caused by demerit goods. These are associated
with information failure, since consumers are not aware of the long run
implications of consuming the good, and they are usually overprovided. For
example, cigarettes and alcohol are demerit goods. The negative externality
to third parties of consuming cigarettes is second-hand smoke or passive
smoking.

Question 25

positive externalities

Answer 25

Positive externalities are caused by merit goods. These are associated with information failure too, because consumers do not realise the long run benefits to consuming the good. They are underprovided in a free market. For example, education and healthcare are merit goods. The positive externality to third parties of education is a higher skilled workforce

Question 26

private costs

Answer 26

Producers are concerned with private costs of production. For example, the rent, the cost of machinery and labour, insurance, transport and paying for raw materials are private costs. This determines how much the producer will supply. It could refer to the market price which the consumer pays for the good.

Question 27

social costs

Answer 27

This is calculated by private costs plus external costs

Question 28

private benefit

Answer 28

Consumers are concerned with the private benefit derived from the consumption of a good. The price the consumer is prepared to pay determines this. Private benefits could also be a firm’s revenue from selling a good.

Question 29

social benefit

Answer 29

private benefits plus external benefits.

Question 30

socially optimum position

Answer 30

This is where MSC = MSB and it is the point of maximum welfare. The social costs made from producing the last unit of output is equal to the social benefit derived from consuming the unit of output.

Question 31

how do you show external costs on a diagram

Answer 31

vertical distance between MSC and MPC

Question 32

where is their deadweight loss

Answer 32

output where social costs > private benefits

Question 33

why does the absence of property rights lead to externalities

Answer 33

where their are no property rights free riders can have unlimited access leading to exploitation of the good moral hazard assumes someone else will pay the consequences

Question 34

demerit goods

Answer 34

cause negative externalities information failure as consumers are not aware of the long term implications of consumption and they are overprovided

Question 35

merit goods

Answer 35

cause positive externalities information failure as consumers are not aware of the long term benefits from consuming them underprovided in free market

Question 36

why does information failure lead to misallocation of resources

Answer 36

Consumers might pay too much or too little, and firms might produce the incorrect amount

Question 37

how can information failure be intervened in

Answer 37

advertising

Question 38

importance of small and medium enterprises

Answer 38

important for creating a competitive market. They create jobs, stimulate innovation and investment and promote a competitive environment.

Question 39

dergulation

Answer 39

the act of reducing how much an industry is regulated. It reduces government power and enhances competition.

Question 40

privatisation

Answer 40

assets are transferred from the public sector to the private sector. In other words, the government sells a firm so that it is no longer in their control. The firm is left to the free market and private individuals.

Question 41

competitive tendering

Answer 41

When a project is put out to tender so that private sector firms can bid for the right to provide the service such as laundry services in hospitals, school meal services and tenders to build and maintain public roads.

Question 42

arguments for nationalised industries

Answer 42

positive externalities reduced costs less profit driven

Question 43

arguments for privatised industries

Answer 43

efficiency gains innovation due to comp raises revenue for gov by selling asset

Question 44

for regulation

Answer 44

externalities disincentives rule breaking

Question 45

for deregulation

Answer 45

less costs for firm less administratitive costs regulation may disincentivise profit due to taxes

Question 46

reguulatory capture

Answer 46

when regulators start acting in the interests of the company, due to impartial information, rather than in consumer interests. This information disadvantage is a problem for regulators.

Question 47

why do government intervene

Answer 47

to correct market failure

Question 48

indirect tax

Answer 48

They increase production costs for producers, so producers supply less. This increases market price and demand contracts. They could be used to discourage the production or consumption of a demerit good or service

Question 49

ad valorem tax

Answer 49

taxes are percentages, such as VAT, which adds 20% of the unit price. less efective if inelastic but gov gain more

Question 50

specific taxes

Answer 50

set tax per unit, such as the 58p per litre fuel duty on unleaded petrol. The more inelastic the demand, the higher the tax burden for the consumer, and the lower the burden of tax for the producer.

Question 51

subsidy

Answer 51

payment from the government to a producer to lower their costs of production and encourage them to produce more. encourage consumption of merit goods Consumers gain more from the subsidy when demand is price inelastic, whilst producers supply more when demand is price elastic.

Question 52

maximum price

Answer 52

consumption or production of a good is to be encouraged. This is so the good does not become too expensive to produce or consume. Maximum prices have to be set below the free market price, otherwise they would be ineffective.

Question 53

minimum price

Answer 53

where the consumption or production of a good is to be discouraged. This ensures the good never falls below a certain price. Minimum prices have to be set above the free market price, otherwise they would be ineffective. The minimum wage could be used as an example.

Question 54

tradeable pollution permits

Answer 54

These could limit the amount of negative externalities, in the form of pollution, created in industries. Firms will be allowed to pollute up to a certain amount, and any surplus on their permit can be traded.

Question 55

adavntages of tradeable pollution permits

Answer 55

This should benefit the environment in the long run, by encouraging firms to use green production methods. The government could raise revenue from the permits, because they can sell them to firms. This revenue could then be reinvested in green technology. If firms exceed their permit, they will have to purchase more permits from firms which did not use their whole permit. This raises revenue for greener firms, who might then invest in green production methods.

Question 56

disadvantages of tradeable pollution permits

Answer 56

it could lead to some firms relocating to where they can pollute without limits, which will reduce their production costs. Firms might pass the higher costs of production onto the consumer. Competition could be restricted in the market, if the permits create a barrier to entry for potential firms. It could be expensive for governments to monitor emissions

Question 57

state provision of public goods

Answer 57

government could provide public goods which are underprovided in the free market, such as education and healthcare. These have external benefits. This makes merit goods more accessible, which might increase their consumption and yield positive externalities. It could be expensive for governments to provide education, and the government will incur an opportunity cost of spending their revenue.

Question 58

provision of information

Answer 58

By providing information, governments can ensure there is no information failure, so consumers and firms can make informed economic decisions. For example, governments might make it illegal for second-hand car dealers not to reveal the entire history of a car, so consumers know exactly what they are buying. This could be expensive to police.

Question 59

regulation

Answer 59

The government could use laws to ban consumers from consuming a good. They could also make it illegal not to do something Firms which fail to follow regulations could face heavy fines, which acts as a disincentive to break the rule. It could raise costs of firms, who might pass on the higher costs to consumers

Question 60

gov failure- distortion of price signals

Answer 60

Government subsidies could distort price signals by distorting the free market mechanism. A free market economist would argue that this could lead to government failure. There could be an inefficient allocation of resources because the market mechanism is not able to act freely

Question 61

gov failure- unintended consequences

Answer 61

actions of producers and consumers have unexpected, or unintended, consequences. With government policies, consumers react in unexpected ways. A policy could be undermined, which could make government policies expensive to implement, since it is harder to achieve their original goals.

Question 62

gov failure- excessive administrative costs

Answer 62

The social benefits of a policy might not be worth the financial cost of administering the policy. It might cost more than the government anticipated. The government has to consider whether the policy is good value for money.

Question 63

gov failure- info gaps

Answer 63

Some policies might be decided without perfect information. This might require a full cost-benefit analysis, and it could be time-consuming and expensive. However, it is impractical for governments to gain every bit of information they need, so assumptions are made