4.1.8 The market mechanism, market failure and government intervention in markets Flashcards
What is Market Failure?
When a free market fails to deliver an efficient allocation of resources, leading to a loss in social welfare
Why aren’t public goods provided in a free market?
Free Rider Problem - consumers can receive benefit but get away without paying for a good/service and therefore private firms can’t make any money off it
(they are non-excludable)
What is a public good?
Ones that are missing from the free market but offer benefits to society (e.g public parks)
These are non-excludable
What does excludable mean? (with an example)
Producers or sellers CAN prevent individuals from consuming (benefitting from) the good if they do not pay for it
What does non-excludable mean? (with an example)
It is difficult or costly to prevent individuals from benefitting from the good, regardless of if they pay for it
What does Rival mean? (with an example)
Consumption by one individual reduces the availability for others
What does non-rival mean?
Consumption by one individual does not reduce the availability for others; it is ‘non-depletable’
What is a Private Good?
Private Good - These are rival and excludable (e.g a chocolate bar)
What is a Quasi Public Good?
These have characteristics of both public and private goods and are partially provided by the free market
(e.g a toll road, you must pay to use them, but one persons use does not reduce the availability on the road for someone else – unless it is rush hour.)
What is a missing market?
This is when public goods are entirely not provided in a free market - complete market failure
What is the Tragedy of the Commons?
Where overconsumption occurs due to rational individuals decisions leading to a damage in the overall social welfare.
It assumes that people make decisions based maximising their own utility, inadvertedly depleting resources in the long run
e.g overfishing
What is an externality?
An externality is the cost or benefit a third party receives from an economic
transaction outside of the market mechanism.
It is the spill-over effect of the production/consumption of a good or service.
What is a positive externality? (with example)
When people don’t take into account the external benefits (Social benefit > private benefit)
Results in underconsumption
(vaccination)
What is a negative externality? (with example)
When people don’t take into account the external costs (Social cost > private cost)
Results in overconsumption (smoking)
How is Social Cost calculated?
Social Cost = Private Cost + External Cost
How is Social Benefit calculated?
Social Benefit = Private Benefit + External Benefit
What is marginal cost/benefit?
The effect of consuming or producing one more unit
MB is equated with the demand curve - marginal benefits fall as you consume more
MC is equated with the supply curve - marginal costs rise as you consume more
What is a demerit good?
cause negative externalities and are associated with information failure.
usually overprovided in a free market
(e.g cigarettes - second-hand smoke)
What is Information Failure?
When consumers are unaware of the long term costs/benefits of consuming a good, leading to under/over consumption
What is a merit good?
cause positive externalities and are also associated with information failure.
usually underprovided in a free market
(e.g university degrees - higher skilled workforce)
What is the socially optimum position?
Where MSC=MSB and is the point of maximum welfare
The social cost of producing the last unit of output is equal to the social benefit of consuming the last unit of output
