4.1.8 - The Market Mechanism , Market Failure And Government Intervention In Markets Flashcards
Define Competition Policy
Is a government policy which seeks to promote competition and efficiency in different markets and industries
Explain what the Competition Markets Authority (CMA) is ?
What do they have the power to do
Uses market structure , conduct and performance to scan the economy and act as a surrogate in a market to make it more competitive.
Can prevent mergers and takeovers
Investigates cartels
Price fixing
Predatory pricing
What is the UK regulatory framework
Occurs where regulatory bodies oversee markets which were formally nationalised industries and are now privatised.
They have the power to investigate competition abuses by companies
What is the EU regulatory framework
Occurs where the EU intervenes when it involves cross- border trade . A firm that sells its products in several EU countries can be investigated for anti-competitive behaviour
Define Government regulations
Are a set of rules which seek to modify the behaviour of firms
List all the types of government regulations (9)
Price control Profit control Windfall tax Quality standards Performance targets Breaking up monopolies Lowering barriers to entry Subsidies Merger policy
Explain price control as a method of government regulation
What are examples of it
Advantages and disadvantages
Is where a regulatory authority sets price limits to keep price rises below inflation.
Minimum pricing (reduced demand and increased producer surplus) and maximum pricing (reduced supply and increased consumer surplus) are methods of price control
A: Allocative efficiency, reduces price discrimination
D: Loss of Dynamic efficiency, Deters new entrants
Explain profit control as a method of government regulation
What are the problems of this method
Involves fixing a maximum level of profit that a firm can earn. The monopolist would make no more profit than if the market was perfectly competitive.
Requires regulators to have a good understanding of costs and profit in the industry, monopolies have little incentive to minimise costs (x-inefficiency)
Explain windfall tax as a method of government regulation
Advantages and disadvantages
Occurs where monopolists make large abnormal profits and governments impose a tax on it
A: can help fund social programs
D: can reduce the profit incentive, dynamic inefficiency
Explain Quality standards as a method of government regulation
Occur due to firms being profit maximisers rather than focusing on good quality. The government can set a minimum quality standard which a firm has to follow
Explain performance targets as a method of government regulation
Occurs where targets like price charged, quality of products or degree of customer choice are set by regulators. If not met regulator fees are charged
Explain breaking up monopolies as a method of government regulation
Reduces monopoly power leading to lower prices and profits
Explain Lowering barriers to entry as a method of government regulation
Is done in the hope that new firms will enter the market and increase competition
Explain subsides as a method of government regulation
Are given to monopolies to increase production and therefore reduce market price
Explain merger policy as a method of government regulation
Involves preventing the merger of two large firms which could have a large market share
Define public ownership
Is the government ownership of firms , industry or other assets
Define Nationalisation
Is the transfer of assets from the private sector to public ownership
What are the arguments for and against nationalisation
For:
Economies of scale- monopoly power leads to reduced unit costs and reduced prices for customers
Increased social welfare- allocatively efficient level of output
Industries like rail, energy and water are too important to be owned privately, who’s main goal is to make a profit
Fairer distribution of resources
Against :
Lack of dynamic efficiency
Lack of expertise in the industry
Reduces competition
Lack of knowledge of changing consumer tastes
Can exert monopsonist power
Define Privatisation
Is the sale of government owned assets to the private sector
What are the arguments for and against privatisation
For: Raises extra revenue for the government Promotes competition Promotes efficiency (due to profit incentive) Improved choice and quality
Against :
Exploitation of monopoly power (profit maximisation)
Decreased consumer surplus
Decreased equity
Explain Labours plan to Nationalise many different UK industries
Labour wanted to renationalise mail delivery, power grid, water and rail.
Nationalising the water and energy industry would cut household costs by £220 a year
Conservatives argued it would add £14 billion to national debt, however the debt would be balanced by acquiring an asset of equivalent value.
Nationalising would mean reduced financing costs but would be run to gain political benefits
Explain Labour’s plan to Nationalise broadband
Labour wanted to nationalise broadband and make it free
Would cost £20-40 billion to nationalise
Would provide equitable distribution
Would cause increased public debt and taxes for consumers
Would reduce costs for businesses who rely on broadband, would also allow increased home working and decreased pollution.
No good examples of nationalised broadband and could damage vital foreign investment into british infrastructure.
Define Deregulation
Is the removal of rules and regulations in order to increase the efficiency of markets
Define market failure
Exists when the competitive outcome of markets is not efficient
Define government failure
Occurs when government intervention leads to a net welfare loss compared to the free market solution
What are the types of government failure (6)
Distortion of price signals Unintended consequences Excessive administration costs Information gaps Conflicting objectives Regulatory capture
Explain distortion of price signals as a method of government failure
Occurs where minimum/maximum price fixes lead to a net welfare loss in the market
Explain unintended consequences as a form of government failure
Give an example
Occurs where some interventions by the government create unintended consequences
For example, the common agricultural policy lead to increased food prices for consumers
Explain excessive administration costs as a form of government failure
Occurs where the administrative costs of correcting market failure is so large that it outweighs the welfare benefit.
Explain information gaps as a form of government intervention
Occurs where governments do not possess complete information to base a decision, may make the wrong policy.
Explain conflicting objectives as a form of government intervention
Give an example
Occurs where there is an opportunity cost in implementing a policy
For example, the government may want to cut taxes but also increase spending on defence.
Explain regulatory capture as a form of government intervention
Occurs where the government operates in favour of producers rather than consumers
Define public choice theory
Is about how and why public spending and taxation decisions are made
Define rent seeking
Is the use of political power by an economic agent to manipulate the distribution of resources for their own benefit.
Define Externalities
Are third party costs or benefits from the consumption or production of a product or service
What is the formula for marginal social cost
What is the formula for marginal social benefit
Private cost + external cost
Private benefit + external benefit
Define Private cost/benefit
Is the cost/benefit of an activity to an individual economic unit, a consumer or firm
What is the Socially optimum level of output
Draw graph
Where Marginal social benefit = Marginal social cost
Define Social cost
What is the relationship with private costs
Is the cost of an activity not just to the individual unit which creates the cost , but the rest of society as well.
If social cost is greater than private cost a negative externality exists
Define Demerit goods
Goods which are thought to be bad for you, consumption can lead to negative externalities
Why do people over consume demerit goods (6)
Temporal myopia (short term thinking) Information failure Information overload Lack of alternatives Addiction Marketing and advertising
Draw the effect of a a demerit good on a graph
X
What are government policy solutions for overconsumption of demerit goods (6)
Minimum price - (alcohol in Scotland)
Indirect taxes - excise duty, VAT
Providing information - labelling, education, advertising
Ban- making products illegal
Substitute products - providing alternatives
Behavioural economic solutions - cigarettes kept out of sight
Define merit goods
Are goods that society values and judges that everyone should have, consumption can lead to positive externalities.
What are the characteristics of merit goods
People under consume them
The government and private sector provide these goods
Social benefit exceeds private benefit
Individuals usually have imperfect information on these goods
What are examples of merit goods
Pensions
Vaccines
Education
Gym memberships (exercise)
Draw a merit good graph
X
What are the government policy solutions for underconsumption of merit goods
Behavioural economic solutions - default choices, Mandated choices and nudges
Simpler information - improve peoples understanding, presentation of options (e.g. five a day campaign advertising)
Providing subsidies - increases supply, cheaper prices for products/services, takes money away from government -> increased tax/debt
Government provision - nationalisation of health and education sector
Taxing negative alternatives - tax on demerit goods
Define Negative Externalities in Production
Are the third party costs of producing a good
State examples of negative externalities in production (3)
Pesticides used in farming which pollute rivers
Damage to ocean beds from intensive fishing
Air pollution caused by manufacturing
Draw and explain a negative externalities in production graph
Assumed that the MPB = MSC
The market equilibrium level of output is where MPB= MPC
Where MSC = MSB is the socially optimum level of output
Net welfare loss from producing the market equilibrium output instead of socially optimum level of output
What are the policy solutions to reduce negative externalities in production
What are the advantages and disadvantages
Tax on production- e.g. pollution tax, congestion charge
A: Ring fencing opportunities (congestion charge spent on improving transport)
D: Hard to asign right level of tax, producers may move to countries with lower tax -> increased unemployment
Subsidising positive externalities in production - Increases their supply and reduces prices, consumers may choose subsidised product over negative production externalities product
Define Positive externalities in production
Are the third party benefits of producing a good
State examples of positive externalities in production
Building a train station which provides shelter for the homeless
A company develops new technology which can be implemented by other firms
Draw and explain the positive externalities in production graph
Shows the potential welfare gain by producing the socially optimum level of output instead of the market forces output
Define public goods
Explain their characteristics
Are goods which when supplied to one individual is immediately available to others at no charge , are non rival and non excludable
Non rival - means that one persons enjoyment of the good does not diminish another persons enjoyment
Non excludable - means that non paying customers cannot be excluded from using a good once its been produced
State examples of public goods
Street lighting - once produced everyone can use it without charge
Flood defences - protecting the coastline from flooding benefits the whole community
Why is a public good under provided in the market
Under provided in a free market due to there not being an incentive to pay. Firms may not provide the good as they have trouble charging for it
Explain the free rider problem
Is the reason for market failure in terms of public goods . Not possible to prevent anyone from consuming a good, people do not pay for it so producers stop producing it.
What are cases for government intervention with public goods
Overcomes the free rider problem
Prevents underconsumption , social welfare is improved
Government provision allows economies of scale
Define property rights
Describes the legal ownership of resources and how they can be used , can be owned by individuals, businesses or governments
Define private goods
Explain their characteristics
Are goods and services sold by private sector businesses which are excludable and rival in consumption
Excludable - where consumers can be excluded from enjoying a product if they are not willing to pay for it , allowing the seller to make a profit and exercise property rights. E.g. Pay per view events
Rival in consumption - where one persons consumption of a good reduces the amount for others to benefit from , scarce resources are used in production
State examples of private goods
Private gyms
Exclusive clubs
Tickets to an event
What is the difference between public and private goods
Consumption of a private good reduces the benefit for someone else, a public good has the same amount of benefit for everyone
Public goods are available for everyone, private goods are only available for those willing to pay for it.
Define Quasi public goods
Explain their characteristics
Is a near public good but does not have all the characteristics.
Semi non rival - Beaches are public goods until they become overcrowded and reduce benefit
Semi non excludable - toll booths charge for road usage on congested roads
What effect do advances in technology have on public and private goods
Causing a blurring of the distinction between public and private goods
E.g. Technology allows sporting events which were private goods and excludable to become non-excludable and public goods through live streaming
Define environmental market failure
Are negative externalities arising from the over- exploitation of environmental resources
Explain the tragedy of the commons
Is the over-exploitation of resources such as oceans, forests or atmosphere that are not owned by individuals or organisations
What are the functions of the price mechanism (4)
What are their relation to market failure
The Rationing function- increasing prices ration demand to those most able to afford a good or service
The Signalling function- prices provide important information to market participants
The Incentive Function - increased prices strengthen incentives for firms to produce more to make a profit.
The Allocative function- diverts resources to where they can maximise their returns and away from users where they don’t
When any of these price functions break down, market failure occurs
Define Complete market failure
Occurs when the free market fails to create a market for a good or service, public good
Define partial market failure
Occurs when a market exists, but does not provide resources in their optimum quantities , over production/consumption and under production/consumption
