4.1.8 — Market Mechanism, Market Failure, Gov Intervention In Markets

Question 1

What are some advantages of the price mechanism and of extending its use into new areas of activity?

Answer 1

• the invisible hand can signal what the cost of purchasing a good is to a consumer (also acts as signal to producers to tell them what revenue they will receive)
• price mechanism allows the consumer to gain sovereignty in the market
• generally the free market allows for an efficient allocation of resources

Question 2

What are some disadvantages of the price mechanism and of extending its use into new areas of activity?

Answer 2

• may be inequality in income and wealth (doesn’t consider what the distribution of income is)
• in a free market, there is under provision of public and merit goods which requires government intervention
• introducing the price mechanism into some fields of human activity could be undesirable

Question 3

What is tragedy of the commons?

Answer 3

This refers to how individuals prioritise personal gain and the well-being of society
> when the resources are held in common, it means no one owns the resource but everyone can access it

I.e no one owns the air, but everyone can use it: this unlimited use leads to the negative externality of air pollution

Question 4

What type of goods are negative externalities caused by?

Answer 4

Demerit goods:

associated with information failure, since consumers are not aware of the long run implications of consuming the good (usually over provided) I.e cigs

Question 5

What type of goods are positive externalities caused by?

Answer 5

Merit goods:

Associated with info failure too, as consumers don’t realise the long run benefits of consuming the good. They are under provided in a free market i.e education, healthcare

Question 6

Why is it difficult to assess the extent of which a market fails (considering a value judgement is used)

Answer 6

Because it is hard to determine what the monetary value of an externality is. I.e it is hard to decide what the cost of pollution to a society is

Question 7

What is a social optimum position?

Answer 7

Where:
marginal social = marginal social
costs benefits

Question 8

What is deadweight welfare loss?

Answer 8

The cost to society created by market inefficiency, which occurs when supply and demand are out of equilibrium

(Shown by triangle in externality diagrams)

Question 9

Alternatively, what is welfare gain?

Answer 9

When the triangle on an externality diagram shows excess of social benefits over costs

Question 10

Why does the absence of property rights lead to externalities in both production and consumption, hence market failure?

Answer 10

• markets become inefficient where there are no property rights
  I.e free riders can have unlimited access to the sea and air: you can’t establish property rights here
• the moral hazard assumes someone else will pay the consequences for a poor choice.
  I.e people might lifter if they think others will clean up after them
• scarce resources could be overused and exploited I.e rainforests are depleting and fish becoming endangered

Question 11

What is the ‘red tape challenge’ which the UK government has established?

Answer 11

It aims to simplify regulation for businesses (especially aimed towards small businesses) making it easier and cheaper to meet environmental targets

Question 12

Why may governments deregulate and privatise a public sector?

Answer 12

Firms can compete in a competitive market which should help improve economic efficiency

Question 13

What is deregulation? What influence does this have on competition?

Answer 13

The act of reducing how much an industry is regulated — it reduces Gov power and enhances competition

Question 14

What is excessive regulation known as?

Answer 14

‘Red tape’: limits the quantity of output that a firm produces. I.e environmental laws and taxes might result in firms only being able to produce a certain quantity before exceeding a pollution permit

Question 15

What does it mean to privatise?

Answer 15

Assets are transferred from the public sector to the private sector. aka the Gov sells a firm so that it is no longer in their control — the firm is left to the free market and private individuals i.e british airways

Question 16

What may free market economists argue about the private sector?

Answer 16

That the private sector gives firms incentives to operate more efficiently which increases economic welfare, as firms operating on the free market have a profit incentive

Increases allocative efficiency meaning higher quality

Question 17

What benefits are there for the government to accept privatisation contracts?

Answer 17

• large (one-off) payment
• saves the Gov money
• frees the Gov of maintenance since the private sector might have the expertise and knowledge to fulfil the project and maintain infrastructure

Question 18

Define nationalisation

Answer 18

The process of taking privately-controlled companies, industries or assets and putting them under the control of the government

> social welfare is typically a priority of a nationalised industry
strong positive externalities I.e using public transport means reduction in pollution etc

Question 19

What can governments achieve through regulation?

Answer 19

Ban consumers, firms etc from consuming certain goods by making it illegal to do something I.e MSG

Making it illegal to not do something I.e minimum school leaving age is 18

Question 20

Why would firms want to abide by set regulations?

Answer 20

To avoid facing heavy fines (which act as a disincentive)
It could raise the costs of firms, who may pass on the higher costs to consumers

Question 21

What is deregulation?

Answer 21

The act of reducing how much an industry is regulated — reduces Gov power and enhances competition

Question 22

Why would firms want to compete in a deregulated public sector?

Answer 22

Because it would improve economic efficiency

Question 23

What is regulatory capture?

Answer 23

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

Question 24

What are property rights?

Answer 24

Document stating the legally enforceable rules for owning, using and selling assets I.e private landowners can ask police to prosecute fly tippers

Question 25

What are the advantages and disadvantages of granting or extending property rights?

Answer 25

Advantages:
- prevents exploitation
- preservation of environment
- encouraged owners to protect resources

Disadvantages:
- complex to implement
- complex to identify
- may be ignored

Question 26

What is a moral hazard?

Answer 26

The tendency for individuals covered by health insurance to be less careful about their health

Question 27

What is adverse selection?

Answer 27

A situation where people whose health risks are greatest are more likely to buy insurance