8 - Market Mechanism and Market Failure Flashcards
1
Q
When does market failure occur?
A
Whenever a market leads to a misallocation of resources.
2
Q
What does market failure distinguish between?
A
Complete market failure and partial market failure.
3
Q
What is partial market failure?
A
The market is functioning, but produces the wrong quantity of a good or service.
4
Q
What does partial market failure lead to?
A
A good being too cheap, and may be over produced or under supplied.
5
Q
What are the examples of market failure?
A
Externalities, lack of competition, public goods, Information Asymmetry.
6
Q
What are externalities?
A
Occurs when production or consumption of a good has an impact on third parties, not reflected in market price.
7
Q
What does lack of competition mean?
A
A market dominated by a small number of firms will have less competition, leading to higher prices for goods and services, can lead to a misallocation of resources.
8
Q
What are public goods?
A
They’re non rival and non excludable.
9
Q
What does non excludable mean?
A
The use by one person of a good doesn’t reduce others’ availability.
10
Q
What is Information Asymmetry?
A
A lack of information about a good or service, can lead to inefficient allocation of resources, as people may not know the true worth of things.
11
Q
What are the characteristics of private goods?
A
Excludable, Rival.
12
Q
What are the characteristics of public goods?
A
Non excludable, Non rival.
13
Q
What are the examples of public goods?
A
Police, Defence, Street lights, Roads, Television, Radio.
14
Q
What are pure public goods?
A
Public goods which are impossible to exclude free riders.
15
Q
What are Quasi public goods?
A
Public goods which are not fully non rival, and where it’s possible to exclude people from consuming the product.
16
Q
How is an optimal level of consumption achieved?
A
When public goods are provided free of charge, but there may be capacity constraints.
17
Q
What are the functions of prices?
A
Signalling Function, Incentive function, Rationing function, Allocative function.
18
Q
What does ‘commons’ refer to?
A
A common resource which provides users with benefits, which nobody has an excising claim to.
19
Q
What does an individual acting in their best interests lead to?
A
Harmful over consumption of a good.
20
Q
What could over consumption lead to?
A
Under investment.
21
Q
When does tragedy of the commons occur?
A
When a good is rival, non excludable, and scarce.
22
Q
What does tragedy of the commons lead to?
A
Each consumer consumes as much as they can, as fast as they can before others deplete it.
23
Q
What is the free rider problem?
A
People who benefit from resources, goods or services which they don’t pay for.
24
Q
What are negative externalities?
A
Costs that spill over to third parties in the production process.
25
Why is pollution a negative externality?
It's a by product of the production of things such as local power stations, and has negative effects on things such as people living nearby.
26
What does pollution as a negative externality represent?
The allocative function of prices breaking down, as the price the consumer pays for the product reflects the money side of production only, not all the costs.
27
What does under pricing of goods encourage?
Too much consumption of electricity.
28
What is the other type of externality?
Negative consumption externalities.
29
What is a consumption externality?
An externality which may be generated in the course of consuming a good or service.
30
What are the examples of negative consumption externalities?
Particles from vehicle pollution, household waste, noise pollution from neighbours, air pollution from smokers, traffic congestion.
31
What is the equation for social benefit?
Private benefit + external benefit.
32
What is the equation for marginal social benefit?
marginal private cost + marginal external cost.
33
What is the equation for marginal social cost?
Marginal private cost + marginal external cost.
34
What are property rights?
The owner of a house has the right to live in a house, and let other members of their family live in their house.
35
What do property rights mean for externalities?
Externalities mean that some of these rights disappear, such as owners not being able to stop passers by from enjoying the view of their house.
36
What is an example of a positive externality?
Education has the private benefit of more personal knowledge, but there is also the wider benefit of a more educated society overall.
37
What is the characteristic of a positive externality?
Social benefit>Private benefit.
38
What do positive externalities lead to?
Under consumption and market failure.
39
How can the government step in to increase demand?
Minimum school leaving age, increasing house building, subsidies to reduce price for consumers.
40
Who are individuals who benefit from positive externalities without paying?
Free riders.
41
What is the assumption in the free market ?
An economic agent only considers private costs and benefits, which ignores costs and benefits to others.
42
How are private benefits maximised?
Marginal private benefit = marginal private cost.
43
How are social benefits maximised?
Marginal social benefit = marginal social cost.
44
What happens when externalities are generated, and benefits are imposed?
Maximising net private benefit doesn't coincide with net social benefit maximisation.
45
What does ABC represent on an externality diagram?
Deadweight loss.
46
Why does deadweight loss exist?
The social cost of producing each unit of electricity is greater than the benefit received by society.
47
What is a welfare gain?
A net gain in social welfare.
48
When do positive consumption externalities occur?
Where marginal social benefit of consumption is higher than marginal private benefit.
49
When do negative consumption externalities occur?
Where the marginal social cost of production is higher than the marginal private cost.
50
How can allocative efficiency occur?
Through competitive markets, if there are economies of scale, if markets are simultaneously in equilibrium.
51
What happens when p=mc?
There are no externalities.
52
How can allocative efficiency be achieved?
Price must equal the true marginal cost of production, the marginal social cost, as well as marginal private cost.
53
What happens when externalities exist?
The market mechanism fails to achieve an allocatively efficient outcome.
54
What is a merit good?
A good for which the social benefits of consumption exceed the private benefits.
55
What do markets do with merit goods?
Under provide them.
56
What is information failure?
Occurs when people make wrong decisions because they don't possess or ignore relevant information.
57
What is social benefit?
The total benefit of an activity, including the external benefit as well as the private benefit.
58
What is the equation for social benefit?
Social benefit = Private benefit + External benefit.
59
What are the two characteristics of a merit good?
Positive consumption externality, information failures.
60
What happens if a person consumes a merit good?
Resulting positive externalities benefit other people.
61
What is a example of social benefit being greater than private benefit?
People cycling to work, as well as making individuals healthier, means less traffic, and congestion, and less pollution.
62
Why can it be argued that merit goods have positive externalities?
Consumption by an individual produces positive externalities, as these goods have more social benefits of consumption, which are enjoyed by the community.
63
What is the effect of education being provided as a free market product?
It would result in under consumption of education, as with all free market provision of merit goods.
64
How is market failure of education corrected?
The government provides a subsidy to reduce the price of education.
65
What happens when a person consumes a demerit good?
Negative externalities are produced, such as second hand smoke. The MSB is less than the MPB.
66
How does information failure affect young people?
It involves younger people getting into habits such as smoking or drinking.
67
Why is information failure in young people harmful?
The long run net benefit of a demerit good is less than the short run benefit.
68
What are the examples of merit goods?
Education, Healthcare, Crash helmets, Car seatbelts, Public parks.
69
What are the examples of demerit goods?
Tobacco, Alcohol, Narcotics, pornography, prostitution.
70
What are the examples of value judgement goods?
Contraception, Sterilisation, Abortion.
71
Why are these goods value judgement goods?
Some people have different values and ethics to other people, so some will view them as merit goods, and some as demerit goods.
72
What does imperfect information result in?
Under provision of merit goods, over provision of demerit goods.
73
What do free market economists believe?
They question the value of naming goods merit or demerit.
74
Why do free market economists question the value of labels?
They believe that government intervention is best when it's minimal, and that people should be able to choose what is best for them, and it's not the state's role.
75
What do anti libertarians argue?
Over consumption of demerit goods, and under consumption of merit goods leads to people being harmed overall.
76
What does consumption of demerit goods lead to?
Negative externalities being dumped on others.
77
What is an example of demerit goods over consumption?
Without taxes being imposed, too much tobacco is consumed.
78
Why are smoking externalities consumption externalities?
They are generated from people smoking.
79
What does smoking mean for the MPB and MSB curve?
The MSB curve is below the MPB curve of the smokers.
80
What do indirect taxes mean for consumption of demerit goods?
Indirect taxes equal to the distance between B and C could bring about the socially optimal level of consumption.
81
What do some argue under consumption of merit goods, and over consumption of demerit goods stem from?
Information failure.
82
What does information failure mean for consumers?
Individuals take account of short term costs and benefits, but ignore or under value long term private costs and benefits?
83
What is asymmetric information?
One party is able to take advantage of another, as they have more knowledge.
84
What is imperfect information?
Economic agents lack information about a good or other information relevant to the transaction.
85
What is monopoly power likely to do in markets?
Restrict market output, and raise prices.
86
What does monopoly power lead to?
Consumer exploitation, and too few of society's scarce resources are allocated to the market in which the monopoly is producing.
87
What is immobility of labour?
The inability of labour to move from one job to another for occupational reasons, such as training, or geographical reasons, such as the cost of moving to a different part of the country.
88
Why is government intervention needed?
Non provision of public goods, under provision of quasi public goods, under provision of merit goods, over provision of demerit goods, lack of market for positive and negative externalities, monopoly power.
89
What are the ways the government can intervene?
Taxation, government spending, maximum and minimum prices, direct provision, regulation, extension of property rights.
90
What do pro free market economists believe?
That the market mechanism achieves a more optimal outcome than through government intervention. They believe that business owners know better than civil servants about what to do with markets.
91
What do interventionist economists believe?
That markets can be uncompetitive, if they are characterised by monopoly power can mean markets are destabilised.
92
How can the government correct market failure?
Government provision of public goods and merit goods, encouraging production and consumption of merit goods, forcing firms and consumers to generate positive externalities.
93
How does government provision of public goods reduce market failure?
The incentive function of prices breaks down when the free rider problem occurs. This means that firms can't make a profit.
94
How can the government encourage production of merit goods?
They regulate or change prices of merit goods, and regulation can force consumers to consume merit goods.
95
How does forcing firms to generate positive externalities reduce market failure?
Regulations can be imposed which forces firms to generate positive externalities.
96
How can governments reduce negative externalities?
Compulsory consumption, subsidies, regulation.
97
How does regulation influence the quantity of negative externalities?
It can put a limit/permit on production.
98
Why is it sometimes impossible to produce a good or service without a negative externality?
The banning of one good may prevent the production of other goods.
99
What is having a growing influence on government?
Congestion and pollution taxes, such as ULEZ, reflecting growing concern about global warming.
100
What do the government calculate about pollution taxes?
The value of the negative externalities, imposing this as a pollution tax.
101
Why pays the pollution tax, and what is this known as?
The producer - 'producer must pay' principle.
102
What do pollution taxes create incentive for?
Less negative externalities to be put onto others, internalising externalities. Means that the polluting firm covers costs of production.
103
What may unintended consequences of pollution taxes be?
Incentives being created to evade tax illegally.
104
What are pollution permits?
A permit to pollute scheme, involving regulation, through imposing maximum limits on the amount of pollution that coal burning power stations can emit.
105
What do energy companies want from pollution permits?
They seek to reduce pollution by more than the law requires them to do, as permits can be sold between different companies.
106
What do price ceilings create?
Excess demand.
107
What would happen to excess demand in a free market?
It would be eliminated, as market forces would raise prices.
108
What do price ceilings cause?
Queues and waiting lists, as households are rationed by households not price.
109
What do price floors create?
Excess supply of labour.
110
What must the price floor be set above?
The free market price.
111
What does a national minimum wage create?
Excess supply of labour, causing unemployment.
112
Why may some employers break the law?
They may pay poverty wages to immigrants.
113
How can indirect tax be charged?
As a unit or a percentage.
114
What happens when tax is charged per unit?
The supply curve shifts upwards to show the additional costs.
115
What happens when tax is charged as a percentage?
Supply curve going upwards, as more tax is collected per unit.
116
What % of tax is paid by the consumer, vs. the supplier?
Consumer - 20%. Producer - 80%.
117
What are the advantages of indirect taxation?
Easier for firms to pay indirect tax than consumers, can be used to make people pay the full social cost of their actions.
118
What are the disadvantages of indirect taxation?
Regressive nature means those on higher incomes pay a lower percentage of income on indirect tax, can encourage tax evasion, or a black market.
119
What is a subsidy?
A government grant paid to producers to encourage production of certain goods or services.
120
What do subsidies do to the price level?
Push it up.
121
What are the advantages of subsidies?
They help support businesses and industries, subsidising a good which is undersupplied covers cost for producers, they're implemented to encourage activities which produce positive externalities.
122
What are the disadvantages of subsidies?
Subsidies unnecessarily distort markets, subsidising helps big businesses, creates an incentive to lobby for subsidies, firms could become reliant on subsidies.
123
What do governments do if they don't think provision shouldn't be left to the free market?
Organise provision of the product, and pay for it with tax revenue.
124
How can governments provide goods?
Pay a private sector firm to complete work for them.
125
What is a regulation?
A rule or law used to control or restrict the actions of economic agents to reduce market failure.
126
What are the examples of market failure regulations?
Banning smoking in public places, minimum legal age to drink alcohol, maximum emission levels on new cars, regulatory bodies.
127
What is the price of pollution permits set by?
Demand and Supply.
128
What does a reduction in property rights lead to?
Reduction in number of permits over time, price increases due to supply and demand, creates a growing incentive to reduce pollution, provides time and incentive to invest.
129
What are the disadvantages of pollution permits?
Difficult to know how many permits to give, difficult to measure pollution levels, administration costs, countries can pollute more, as countries can buy more from other countries.
130
What are the examples of pollution permits?
EU ETS, UK ETS.
131
When does government failure occur?
When government intervention reduces economic welfare, leading to a worse allocation of resources than the free market outcome.
132
What are the reasons for government failure?
Inadequate information, Unintended consequences, Administrative costs, market distortion, regulatory capture.
133
How does inadequate information cause government failure?
Governments rarely possess complete information on which to base a decision.
134
What is an example of inadequate information in government?
Government having to make decisions about whether to fund a selective or comprehensive school system.
135
What are unintended consequences?
Whenever the government intervenes in the market, there will be effects which aren't foreseen.
136
What is an example of unintended consequences?
A tax on smoking causing a rise in vaping.
137
How do administrative costs cause market failure?
Can create unnecessary layers of bureaucracy, creating extra costs.
138
What is market distortion?
Government intervention to correct one market causes the creation of more serious market failures.
139
What is an example of market distortion?
Income tax can act as a disincentive to working hard. Increased earnings means paying more income tax.
140
What is regulatory capture?
Regulatory agencies may be dominated by the interests they regulate, but not the public interest.
141
What is an example of government failure?
Rent controls.
142
What are rent controls?
The maximum price a landlord is allowed to charge a tenant?
143
What do rent controls lead to?
Landlords earn less, landlords could ignore the law, using cash only, housing companies may have to lay off workers to lower expenses.
144
What is Public ownership also called?
Nationalisation.
145
When did periods of nationalisation occur in the UK?
After the second world war, from 1945-1951, and 1964-1979.
146
Which sectors were brought into public ownership during this period?
Coal, Railways and Steel.
147
What are the two examples of temporary renationalisation?
The Banking system, including RBS, HBOS, Northern Rock. Railways - Including Transpennine express, and East Coast Rail.
148
What is Privatisation?
The transfer of publicly owned assets to the private sector, involving the sale to private ownership.
149
How many industries were nationalised between 1981-2015?
16.
150
What are the reasons for privatisation?
Revenue Raising, Reducing public spending, Promoting competition, promoting efficiency, popular capitalism.
151
How does privatisation raise revenue?
It provides the government with short term revenue, which can be worth up to £3 billion per year.
152
How does privatisation reduce public spending?
After privatisation, public spending on subsidies fell, and if an industry returns to profitability, borrowing falls, as corporation tax revenue is boosted as well.
153
How does privatisation promote competition?
Privatisation breaks up monopoly power, as industries such as gas and electric became non-monopolies, due to lower barriers to entry, and the increase of regulatory bodies such as Ofgem.
154
How does privatisation promote efficiency?
This occurs because private firms are focused on increasing profit, as well as the threat of takeover, makes firms more efficient.
155
How does privatisation promote popular capitalism?
It promotes an enterprise culture, and extended share ownership to employees and others who didn't own shares before.
156
What are the reasons against privatisation?
Monopoly abuse, short termism vs long termism, selling valuable assets too cheaply, assets are sold just to fund government spending.
157
How does privatisation increase monopoly abuse?
Privatisation could increase monopoly abuse by transferring socially owned, accountable, public monopolies, to non-accountable monopolies.
158
How does privatisation increase short term thinking?
Investments will often not be made by private firms, as boards of companies have to concentrate on delivering dividends.
159
Why is it bad to sell assets to fuel government spending?
Taxpayers shouldn't have to sanction the sale of capital assets owned by the government, in order to fund current spending only.
160
Why is bad for the government to sell assets too cheaply?
The offer price of shares is pitched at a level which guarantees risk free capital gain.
161
What is regulation?
The imposition of rules and other constraints, restricting freedom of economic action.
162
What is external regulation?
An external agency laying down, enforcing rules and constraints. e.g. CMA.
163
What is involuntary regulation?
A group of individuals or firms regulating themselves.
164
How do governments use regulation?
To try and correct market failures, and achieve a socially optimal level of production and consumption.
165
What are the examples of government regulation reducing social cost?
Health and safety act, anti discrimination laws, workers' rights legislation, consumer protection legislation.
166
What are the advantages of government regulation?
Protects consumers from harmful products, protects workers from labour market exploitation, protects the environment, protects the most vulnerable from exploitation and abuse.
167
What is deregulation?
The removal of previously imposed regulations, which restrict the freedom of market activity.
168
What are the justifications of deregulation?
Promotes competition through removing barriers to market entry, removes bureaucracy, which imposes unnecessary costs on economic agents.
169
Why is deregulation needed?
Gets rid of unnecessary bureaucracy, removes compliance costs, removes interference in economic decision making.
170
What does the contestable market theory state?
Argues that the most effective way to promote competitive behaviour is to carry out deregulation.
171
What do governments do, as a result of the contestable theory?
Governments have aimed to remove regulations which aimed to reduce competition.
172
What is Regulatory Capture?
Occurs when regulatory agencies act in the interest of regulated firms rather than on behalf of firms they should protect.
173
What is an example of regulatory capture
Oflot was caught accepting free air tickets from one of the companies it was regulating.
174
How do regulators act as an informal tax?
Regulators have an incentive to extend their role by introducing more rules and regulations, and raises production costs and consumer prices.
