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

Question 1

Signalling function of prices

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 behaviour e.g. a higher price creates an incentive for firms to supply more of a good/service

Question 3

Rationing function of prices

Answer 3

Rising prices ration demand for a product

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’s excess demand

Question 5

Market failure

Answer 5

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

Question 6

Missing market

Answer 6

A situation in which there’s no market because the functions of prices have broken down.

Question 7

Private good

Answer 7

A good that is excludable and rival

Question 8

Public good

Answer 8

A good that is non-excludable and non-rival

Question 9

Quasi-public good

Answer 9

A good which isn’t fully non-rival and/or where it’s possible to exclude people from consuming the product e.g. roads

Question 10

Externality

Answer 10

A public good, in the case of an external benefit, or a public bad, in the case of an external cost, that is ‘dumped’ on third parties outside the market.

Question 11

Positive externality

Answer 11

Same as an external benefit, occurs when the consumption or production of a good causes a benefit to a third party, where the social benefit is greater than the private benefit

Question 12

Negative externality

Answer 12

Same as an external cost, occurs when the consumption of production of a good causes costs to a third party, where the social cost is greater than the private cost

Question 13

Production exernality

Answer 13

An externality (which may be positive or negative) generated in the course of producing a good/service

Question 14

Consumption externality

Answer 14

An externality (which may be positive or negative) generated in the course of consuming a good/service

Question 15

Social benefit

Answer 15

The total benefit of an activity, including the external benefit as well as the private benefit.
Social benefit=private benefit+external benefit

Question 16

Merit good

Answer 16

A good for which the social benefits of consumption exceed the private benefits. Value judgements are involved in deciding that a good is a merit good

Question 17

Subsidy

Answer 17

A payment made by government or other authority, usually to producers for each unit of the subsidised good that they produce. Consumers can also be subsidised

Question 18

Demerit good

Answer 18

A good for which the social costs of consumption exceed the private costs. Value judgements are involved in deciding that a good is a demerit good

Question 19

Social cost

Answer 19

The total cost of an activity, including the external cost as well as the private cost.
Social cost= private cost+external cost

Question 20

Information problem

Answer 20

Occurs when people make wrong decisions as they don’t possess or ignore relevant information. \very often they are myopic (short-sighted) about the future

Question 21

Immobility of labour

Answer 21

The inability of labour to move from one job to another, either for occupational reasons or for geographical reasons

Question 22

Geographical immobility of labour

Answer 22

Occurs when workers find it hard or impossible to move to jobs in other parts of the country or in other countries for reasons such as higher housing costs in locations where the jobs exist

Question 23

Occupational immobility of labour

Answer 23

Occurs when workers find it hard or impossible to move between jobs as they lack or can’t develop the skills needed for the new jobs

Question 24

Equity

Answer 24

Fairness or justness

Question 25

Inequity

Answer 25

Unfairness or unjustness

Question 26

Distribution of income and wealth

Answer 26

The way in which income and wealth are divides among the population

Question 27

Regulation

Answer 27

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

Question 28

Tax

Answer 28

A compulsory levy imposed by the government to pay for its activities. Taxes can also be used to achieve other objectives

Question 29

Price ceiling

Answer 29

A price above which it’s illegal to trade. Price ceilings or maximum legal prices, can distort markets by creating excess demand

Question 30

Price floor

Answer 30

A price below which it’s illegal to trade. Price floors or minimum legal prices can distort markets by creating excess supply

Question 31

Government failure

Answer 31

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