8 - Market Mechanism and Market Failure Flashcards
When does market failure occur?
Whenever a market leads to a misallocation of resources.
What does market failure distinguish between?
Complete market failure and partial market failure.
What is partial market failure?
The market is functioning, but produces the wrong quantity of a good or service.
What does partial market failure lead to?
A good being too cheap, and may be over produced or under supplied.
What are the examples of market failure?
Externalities, lack of competition, public goods, Information Asymmetry.
What are externalities?
Occurs when production or consumption of a good has an impact on third parties, not reflected in market price.
What does lack of competition mean?
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.
What are public goods?
They’re non rival and non excludable.
What does non excludable mean?
The use by one person of a good doesn’t reduce others’ availability.
What is Information Asymmetry?
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.
What are the characteristics of private goods?
Excludable, Rival.
What are the characteristics of public goods?
Non excludable, Non rival.
What are the examples of public goods?
Police, Defence, Street lights, Roads, Television, Radio.
What are pure public goods?
Public goods which are impossible to exclude free riders.
What are Quasi public goods?
Public goods which are not fully non rival, and where it’s possible to exclude people from consuming the product.
How is an optimal level of consumption achieved?
When public goods are provided free of charge, but there may be capacity constraints.
What are the functions of prices?
Signalling Function, Incentive function, Rationing function, Allocative function.
What does ‘commons’ refer to?
A common resource which provides users with benefits, which nobody has an excising claim to.
What does an individual acting in their best interests lead to?
Harmful over consumption of a good.
What could over consumption lead to?
Under investment.
When does tragedy of the commons occur?
When a good is rival, non excludable, and scarce.
What does tragedy of the commons lead to?
Each consumer consumes as much as they can, as fast as they can before others deplete it.
What is the free rider problem?
People who benefit from resources, goods or services which they don’t pay for.
What are negative externalities?
Costs that spill over to third parties in the production process.
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.
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.
What does under pricing of goods encourage?
Too much consumption of electricity.
What is the other type of externality?
Negative consumption externalities.
What is a consumption externality?
An externality which may be generated in the course of consuming a good or service.
What are the examples of negative consumption externalities?
Particles from vehicle pollution, household waste, noise pollution from neighbours, air pollution from smokers, traffic congestion.
What is the equation for social benefit?
Private benefit + external benefit.
What is the equation for marginal social benefit?
marginal private cost + marginal external cost.
What is the equation for marginal social cost?
Marginal private cost + marginal external cost.
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.
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.
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.
What is the characteristic of a positive externality?
Social benefit>Private benefit.
What do positive externalities lead to?
Under consumption and market failure.
How can the government step in to increase demand?
Minimum school leaving age, increasing house building, subsidies to reduce price for consumers.
Who are individuals who benefit from positive externalities without paying?
Free riders.
What is the assumption in the free market ?
An economic agent only considers private costs and benefits, which ignores costs and benefits to others.
How are private benefits maximised?
Marginal private benefit = marginal private cost.
How are social benefits maximised?
Marginal social benefit = marginal social cost.
What happens when externalities are generated, and benefits are imposed?
Maximising net private benefit doesn’t coincide with net social benefit maximisation.
What does ABC represent on an externality diagram?
Deadweight loss.
Why does deadweight loss exist?
The social cost of producing each unit of electricity is greater than the benefit received by society.
What is a welfare gain?
A net gain in social welfare.
When do positive consumption externalities occur?
Where marginal social benefit of consumption is higher than marginal private benefit.
When do negative consumption externalities occur?
Where the marginal social cost of production is higher than the marginal private cost.
How can allocative efficiency occur?
Through competitive markets, if there are economies of scale, if markets are simultaneously in equilibrium.
What happens when p=mc?
There are no externalities.
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.
What happens when externalities exist?
The market mechanism fails to achieve an allocatively efficient outcome.
What is a merit good?
A good for which the social benefits of consumption exceed the private benefits.
What do markets do with merit goods?
Under provide them.
What is information failure?
Occurs when people make wrong decisions because they don’t possess or ignore relevant information.
What is social benefit?
The total benefit of an activity, including the external benefit as well as the private benefit.
What is the equation for social benefit?
Social benefit = Private benefit + External benefit.
What are the two characteristics of a merit good?
Positive consumption externality, information failures.
What happens if a person consumes a merit good?
Resulting positive externalities benefit other people.
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.
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.
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.
How is market failure of education corrected?
The government provides a subsidy to reduce the price of education.
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.
How does information failure affect young people?
It involves younger people getting into habits such as smoking or drinking.
Why is information failure in young people harmful?
The long run net benefit of a demerit good is less than the short run benefit.
What are the examples of merit goods?
Education, Healthcare, Crash helmets, Car seatbelts, Public parks.
What are the examples of demerit goods?
Tobacco, Alcohol, Narcotics, pornography, prostitution.
