8.2 The Meaning Of Market Failure

Question 1

What is market failure?

Answer 1

• Market failure occurs whenever a market leads to a misallocation of resources.
• Economic and social welfare is not maximised where there is market failure.

Question 2

What is meant by a misallocation of resources?

Answer 2

• when resources are not allocated to the best interests of society.
• there could be more output in the form of goods and services if the resources were used in a different way.

Question 3

What are some types of market failure?

Answer 3

• Externalities
• The under-provision of public goods
• Information gaps
• Monopolies
• Inequalities in the distribution of income and wealth

Question 4

Types of market failure-externalities

Answer 4

• An externality is the cost or benefit a third party receives from an economic
  transaction outside of the market mechanism.
• In other words, it is the spill-over effect of the production or consumption of a good or service.
• Negative
  externalities are caused by the consumption of demerit goods, such as
  cigarettes
• Positive externalities are caused by the consumption of merit goods, such as recycling schemes.

Question 5

Types of market failure-the under-provision of public goods

Answer 5

• Public goods are non-excludable and non-rival, and they are underprovided in
  a free market because of the free-rider problem.

Question 6

Types of market failure-information gaps

Answer 6

• It is assumed that consumers and producers have perfect information when
  making economic decisions.
• However, this is rarely the case, and this imperfect information leads to a misallocation of resources.

Question 7

Types of market failure-monopolies

Answer 7

• Since the consumer has very little choice where to buy the goods and services
  offered by a monopoly, they are often overcharged.
• This leads to the under-consumption of the good or service, and therefore there is a misallocation of resources, since consumer needs and wants are not fully met.

Question 8

Types of market failure-Inequalities in the distribution of income and wealth

Answer 8

• There is an unequitable distribution in income and wealth.
• Income refers to a flow of money, whilst wealth refers to a stock of assets.
• This can lead to negative externalities, such as social unrest.

Question 9

What is complete market failure?

Answer 9

• Complete market failure occurs when there is a missing market.
• The market does not supply the products at all.

Question 10

What is partial market failure?

Answer 10

• Partial market failure occurs when the market produces a good, but it is the wrong quantity or the wrong price.
• Resources are misallocated where there is partial market failure.