4.1.8.2 The meaning of market failure

Question 2

What is market failure?

Answer 2

When markets misallocate resources, failing to maximize social welfare.

Results in either missing markets (complete) or incorrect quantity/price (partial).

Question 3

Distinguish complete and partial market failure.

Answer 3

Complete: No market exists (e.g., pure public goods like national defense).
Partial: Market exists but is inefficient (e.g., monopolies overcharging).

Question 4

How do externalities cause market failure?

Answer 4

Negative: Third-party costs (e.g., pollution from factories).
Positive: Third-party benefits (e.g., education → skilled workforce).

Example: Cigarettes (demerit good) vs. vaccines (merit good).

Question 5

Why are public goods underprovided?

Answer 5

Non-excludable (can’t exclude non-payers) + non-rival (use by one doesn’t reduce availability).

Example: Street lighting.

Question 6

How do information gaps lead to failure?

Answer 6

Consumers/producers lack perfect knowledge → poor decisions.

Example: Hidden fees in financial products.

Question 7

Why do monopolies fail markets?

Answer 7

High prices → underconsumption.
Restricted choice → unmet consumer needs.

Example: Microsoft in 1990s OS market.

Question 8

How does inequality cause market failure?

Answer 8

Unequal ‘spending votes’ → resources favor the wealthy.
Social unrest: Negative externality.

Example: Luxury housing vs. homelessness.

Question 9

How do merit and demerit goods relate to market failure?

Answer 9

Merit goods (e.g., education): Underconsumed due to information gaps.
Demerit goods (e.g., alcohol): Overconsumed due to ignored external costs.

Question 10

Give examples of complete/partial market failure.

Answer 10

Complete: No market for asteroid defense.
Partial: Healthcare (wrong price/quantity due to monopolies or information gaps).

Question 11

Draw a negative externality diagram. Label: Social cost > Private cost, Deadweight loss.

Answer 11

MPC curve below MSC → overproduction at Qₘₐʀᴋᴇᴛ vs. Qₒₚᴛ.

Question 12

Is all market failure bad?

Answer 12

Yes: Inefficient → lost welfare.
No: Some inequality may incentivize innovation.

Question 13

How does this link to government intervention?

Answer 13

Solutions: Taxes (negative externalities), subsidies (positive), public provision (public goods).