6. Revisiting market failure and government intervention in markets

Question 1

Market failure

Answer 1

Occurs when the price mechanism fails to allocate scarce resources in a productively efficient way and when the operation of market forces leads to an allocatively inefficient outcome

Question 2

Complete market failure

Answer 2

A market fails to function at all and a ‘missing market’ results

Question 3

Partial market failure

Answer 3

A market does function but it delivers the ‘wrong’ quantity of a good or service which results in resource misallocation

Question 4

Missing market

Answer 4

The absence of a market for a good or service, most commonly in the case of public goods and externalities

Question 5

Private good

Answer 5

A good which exhibits the characteristics of excludability and rivalry

Question 6

Property right

Answer 6

The exclusive authority to determine how a resource is used. In the case of a private property right, the owner of private property such as a bar of chocolate has the right to prevent other people from consuming it unless they are prepared to pay a price to the owner

Question 7

Public good

Answer 7

A good which exhibits the characteristics of non excludability and non rivalry

Question 8

Non excludability

Answer 8

A property of a public good which means if it is provided for one person it is provide for all

Question 9

Non rivalry

Answer 9

A property of a public good which means that when a good is consumed by one person, it doesn’t reduce the amount available for others

Question 10

Non rejectability

Answer 10

A property of a public good which means that when a good is consumed by one person, it does not reduce the amount available for others

Question 11

Free rider problem

Answer 11

Occurs when non excludability leads to a situation in which not enough consumers choose to pay for a good, preferring instead to free ride, with the result that the incentive to provide the good through the market disappears and a missing market may result. (A free rider is someone who benefits without paying)

Question 12

Quasi public good

Answer 12

A good which has characteristics of both a public and private good - e.g. it may be non excludable but rival, or excludable but non rival

Question 13

Externality

Answer 13

Occurs when production or consumption of goods / services impose external costs or benefits on third parties outside of the market without these being reflected in market prices. When an external cost is generated, there is a divergence between private and social costs and benefits, there is a divergence between private and social costs and benefits

Question 14

Negative externality

Answer 14

A cost that is suffered by a 3rd party as a result of an economic transaction. In the transaction, the producer and consumer are the first and second parties, and the third parties include other people or firms affected by the transaction. Pollution is a negative externality when unwillingly consumed by third parties. (Dumped on 3rd parties outside the market)

Question 15

Positive externality

Answer 15

A benefit that is enjoyed by a third party as a result of an economic transaction e.g. a beautiful garden, visible to third parties

Question 16

Production externality

Answer 16

When production of a good or service imposes external costs or benefits on 3rd parties outside of the market without these being reflected in market prices

Question 17

Consumption externality

Answer 17

When consumption of a good or service imposes external costs or benefits on third parties outside of the market without these being reflected in market price

Question 18

Demerit good

Answer 18

A good for which the private benefits of consumption are greater than the social benefits and for which the long term private benefits are less than the short term benefit

Question 19

Merit good

Answer 19

A good for which the social benefits of consumption exceed the private benefit and for which the long term private benefits are less than the short term benefit

Question 20

Moral hazard

Answer 20

The tendency of individuals and firms, once insured against some contingency, to behave so as to make that contingency more likely

Question 21

Adverse selection

Answer 21

A situation in which people who buy insurance often have a better idea of the risks than do the sellers of insurance. People who know they face large risks are more likely to buy insurance than people who face small risks

Question 22

Competition policy

Answer 22

The part of the government’s microeconomic policy which aims to make goods markets more competitive. It comprises policy toward monopoly, mergers and restrictive trading practices

Question 23

Competition and Markets Authority

Answer 23

Government agency responsible for advising on and implementing UK competition policy

Question 24

Public ownership

Answer 24

Ownership of industries, firms and other assets such as social housing by central or local government. The state’s acquisition of such assets is called nationalisation

Question 25

Privatisation

Answer 25

The transfer of assets from the public sector to private sector

Question 26

Regulation

Answer 26

The imposition of rules and other constraints which restrict freedom and economic action

Question 27

Deregulation

Answer 27

The removal of previously imposed regulations

Question 28

Regulatory capture

Answer 28

Occurs when regulatory agencies act in the interest of regulated firms rather on behalf of the consumers they are supposed to protect