5 The market mechanism, market failure and government intervention in markets

Question 1

signalling function of prices definition

Answer 1

prices provide information to buyers and sellers

Question 2

incentive function of prices

Answer 2

prices create incentives for people to alter their economic behavior

e.g higher prices incentives firms to supply more

Question 3

rationing function of prices definition

Answer 3

rising prices ration demand for product

price rises, to meet excess demand and shortage supply at equilibrium

Question 4

allocative function of prices

Answer 4

changing relative prices allocate scarce resources away from markets exhibiting excess supply and into markets in which there is excess demand

Question 5

market failure definition

Answer 5

when the market mechanism leads to a misallocation of resources in the economy, either completely failing to provide a good or service or providing the wrong quantity

Question 6

missing market definition

Answer 6

a situation in which there is no market because the functions of prices have broken down

Question 7

private good definition

Answer 7

a good, such as an orange, that is excludable and rival

Question 8

public good definition

Answer 8

a good, such as a radio programme, that is non-excludable and non-rival

Question 9

quasi-public good definition

Answer 9

a good which is not fully non-rival and/or where it is possible to exclude people from consuming the product

Question 10

externality definition

Answer 10

public good/bad that causes either a positive or a negative effect on third parties outside of the market

Question 11

positive externality definition

Answer 11

occurs when the consumption or production of a good causes a benefit to a third party

• social benefits > private benefit

Question 12

negative externality definition

Answer 12

occurs when the consumption or production of a good causes a cost to a third party

• social cost > private cost

Question 13

production externality definition

Answer 13

an externaility (which may be positive or negative) generated in the course of producing a good or service

Question 14

consumption exernality definition

Answer 14

an externaility (which may be positive or negative) generated in the course of consuming a good or service

Question 15

social benefit definition

Answer 15

the total benefit of an activity, including the external benefit as well as the private benefit.

Question 16

what is the social benefit equation

Answer 16

private benefit + external benefit

Question 17

merit good definition

Answer 17

a good, such as healthcare, for which the social benefits of consumption exceed the private benefits

Question 18

How can it be decided whether a good is a merit good or a demerit good or not at all

Answer 18

through valued judgment

Question 19

subsidy definition

Answer 19

a payment made by the government or other authority, usually to producers.

• for each unit of the subsidised good produced the consumers will also be subsidised

Question 20

demerit good definition

Answer 20

a good for which the social costs of consumption exceed the private costs

Question 21

social cost definition

Answer 21

the total cost of an activity, including the external cost as well as the private cost

Question 22

what is the equation for social cost

Answer 22

social cost = private cost + external cost

Question 23

immobility of labour definition

Answer 23

the inability of labour to move from one job to another,
either for;
- occupational reasons
- geographical reasons

Question 24

geographical immobility of labour definition

Answer 24

occurs when workers find it difficult/impossible to move to jobs in other parts of the country or in other countries

Question 25

occupational immobility of labour definition

Answer 25

occurs when workers when workers find it difficult or impossible to move between jobs because they lack or cannot develop the skills needed for the new jobs

Question 26

equity definition

Answer 26

fairness or justness

Question 27

inequity definition

Answer 27

unfairness or unjustness

Question 28

distribution of income and wealth definition

Answer 28

the way in which income and wealth are divided within the population

Question 29

regulation definition

Answer 29

involves the imposition of rules, controls and constraints, which restrict freedom and economic action in the market place

Question 30

tax definition

Answer 30

a compulsory levy imposed by the government to pay for its activities,
used for other reasons too;
- reduce consumption of demerit goods

Question 31

price ceiling definition

Answer 31

a price above which it is illegal to trade.
- can distort markets by creating excess demand

Question 32

price floor definition

Answer 32

a price below which it is illegal to trade.
- can distort by creating excess supply

Question 33

government failure definition

Answer 33

occurs when government intervention reduces economic welfare, leading to an allocation of resources that is worse than the free-market outcome

Question 34

what are the 4 functions of prices

Answer 34

• signalling
• incentive
• rationing
• allocative

Question 35

when do markets perform well

Answer 35

when all the 4 functions of prices perform well

Question 36

when does market failure occur

Answer 36

when 1 of the 4 functions of prices break down

Question 37

2 examples of a public good

Answer 37

• light house light
• national defence

Question 38

example of a private good

Answer 38

chocolate, once eaten no one else can consume

Question 39

example of quasi-public good

Answer 39

roads
- open to all, but can be restricted