Ch-2 Market Failure Flashcards
Q1) What is market failure
🔷 market failure is a situation in which the free market leads to misallocation of society’s scare resources in the sense that there is either over production or under production of particular goods and services leading to a less than optimal outcome.
🔷 Market failures are situation in which a particular market become inefficient.
🔷 There are two aspects of market failures namely, demand-side market failures and supply side market failures.
Demand side market failures are said to occur when the demand curves do not take into account the full willingness of consumers to pay for a product. For example, none of us will be willing to pay to view a wayside fountain because we can view it without paying.
Supply-side market failures happen when supply curves do not incorporate the full cost of producing the product. For example, a thermal power plant that uses coal do not include costs to the society caused by fumes discharges into the atmosphere as part of the cost of producing electricity.
Q2) why do Markets fail ?
🔷There are four major reasons for market failure. They are:
(a) Market power
(b) Externalities. (C) Public goods, and
(d) Incomplete information
(i) Market power of firms enables them to act as price makers and keep the level of prices and output that give them positive economic profits.
(ii) Externalities hinder the ability of market prices to convey accurate information about how much to produce and how much to buy.
(iii) Public goods are not produced at all or produced less than optimal quantities due to its special characteristics such as indivisibility, non-excludability and non-rivalry.Free rider problem causing overuse, degradation and depletion of common resources.
(iv) Information failure manifest in asymmetric information, adverse selection and moral hazard.
Q3) what is market power ? What is its disadvantage ?
🔷market power on Monopoly power is the ability of a firm to profitably raise the market price of a good or service over its marginal cost.
🔷firms that have market power are price makers and therefore , can change a price that gives them positive economic profits.
DISADVANTAGE OF MARKET POWER:
(1) Market power is an important cause of market failure Market failure occurs when there is inefficient allocation of resources.
(2) Market power can cause markets to be inefficient because it keeps price and output away from the equilib rium of supply and demand.
(3) Market power contributes to efficiency because it results in higher prices than competitive prices.
(4) in addition market power also tends to restrict output and leads to deadweight loss.
(5) excessive market power causes the single producer or a small number at producers to produce and sell output than would be produced in a competitive market.
(6) Market power thus results in suboptimal outcomes such as deadweight loss, underproduction of goods and services, higher prices and loss of consumer surplus.
Q4) what is externalities?
🔷Such costs or benefits which are not accounted in the market price are called externalities because they are “external” to the market.
🔷the unique feature of an externality is that it is initiated and experienced not through the operation of the price system , but outside the market . since it occurs outside the price mechanism , it has not been compensated for, or in other words it is uninternalized or the cost of it is not born by the parties.
🔷Externalities are also referred to as ‘spillover effects, ‘neighbourhood effects third-party effects’ or ‘side effects
🔷 Externalities may be unidirectional or reciprocal. Suppose a workshop creates a very loud noise to baket who produces smoke and harm the workers in the workshop, then this is a case of reciprocal externality it an accountant who is disturbed by loud music but has not imposed any externality on the singers, then the externality is unidirectional
🔷Externalities can be positive or negative. Negative externalities occur when the action of one party imposes costs on another party Positive externalities occur when the action of one party results into benefits on another party
Q6) why problem of negative externalities are not given importance?
🔷when firms do not worry about the negative externalities associated with their production, the result is excess production and unnecessary social cost .
🔷the problem , though serious, does not usually float up or given importance because:
🔹the society does not know precisely who are the producers of harmful externalities.
🔹even if the society knows it, the cause- effect linkages are so unclear that the negative externality cannot be directly traced to its producer.
Q7) what are social costs ?
🔷Social costs refer to the total costs to the society on account of a production or consumption activity.
🔷Social costs are private costs borne by individuals directly involved in a transaction together with the external costs borne by third parties not directly involved in the transaction. Social Cost = Private Cost + External Cost
🔷The presence of externalities creates a divergence between private and social costs of production.
When negative production externalities exist , social costs exceed private cost because the true social cost of production would be private cost plus the cost of the damage from externalities. If producers do not take to account the externalities, there will be over production and market failure.
Applying the same logic, negative consumption externalities lead to a situation where the social benefit of consumption is less than the private benefit.
Q8) what is private cost?
🔷 private cost is the cost faced by the producer or consumer directly involved in a transaction.
🔷if it take the case of a producer , his private cost includes direct cost of labour ,materials ,energy and other indirect overheads.
🔷firms do not have to pay for the damage resulting from the pollution with they generate.
🔷as a result , each firms private cost would be the direct cost of production only which does not incorporate externalities.
Q9) give few examples of public goods and private goods?
🔷a few examples of public goods are : National defence , highways , public education , scientific research which benefits everyone , law enforcement , lighthouses , fire protection , disease prevention and public sanitation.
🔷 a few examples of private goods are : food items, clothing, movie ticket , television , cars , houses etc.
Q10) what are characteristics (features) of private goods?
(1) Private goods refer to those goods that yield utility to people. Anyone who wants to consume them must purchase them.
(2) Owners of private goods can exercise private property rights and can prevent others from using the good or consuming their benefits.
3) Consumption of private goods is ‘rivalrous that is the purchase and consumption of a private good by one Individual prevents another individual from consuming it. In other words, simultaneous consumption of a rivalrous good by more than one person is impossible .
EXTRA KNOWLEDGE :Only one consumer will drink the coffee, and after it is gone, there will be nothing left for another consumer to use.
(4) Private goods are excludable i.e. it is possible to exclude or prevent consumers who have not paid for them from consuming them or having access to them.Example: Private parks
(5) Private goods do not have the free rider problem. This means that the private goods will be available to only those persons who are willing to pay for it.It is not available free for all .
EXTRA KNOWLEDGE : An example for free rider is someone who does not pay his or her share of taxes after benefiting from roads, water treatment plants, free education etc. Free rider problem is thus associated with the consumption of public goods.
(6) Private goods can be parceled out(divided) among different individuals and therefore, it is possible to refer to total consumption as the sum of each individual’s consumption.
(7) all private goods and services can be rejected by the consumers if their needs, preferences or budgets change.
(8) Additional resource costs are involved for producing and supplying additional quantities of private goods.
(9) Whenever there is inequality in income distribution in an economy, issues of fairness and justice tend to arise with respect to private goods.
(10) Normally, the market will efficiently allocate resources for the production of private goods.
Q11) what are characteristics (features) of public goods ?
[1]Public goods are products whose consumption is essentially collective in nature. No direct payment by the consumer is involved.
2) Public good is non-rival in consumption. It means that consumption of a public good by one individual does not reduce the quality or quantity available for all other individuals.
EXTRA KNOWLEDGE : When consumed by one person, it can be consumed in equal amounts by the rest of the persons in the society. That is your consumption of a public good in no way interferes with its consumption by other people. For example, if you eat your apple, another person too cannot eat it This is private good. But if you walk in street light, other persons too can walk without any reduced benefit from the street light.This is public goods.
3) Public goods are non-excludable. Consumers cannot be excluded from consumption benefits. If the good is provided, one individual cannot deny other individuals’ consumption. Provision of a public good at all by government means provision for all. For example national defence once provided, it is impossible to exclude anyone within the country from consuming and benefiting from it.
4) Public goods are characterized by indivisibility. For example, you can buy or ice cream as separate units, but a lighthouse, a highway, an defence, clean air etc cannot be consumed in separate units. In the case of public goods, each individual may consume all of the good i.e. the total amount consumed is the same for each individual.
5) Public goods are generally more vulnerable to issues such as externalities inadequate property rights, and free rider problems.
Q13) what is pure public goods?
🔷pure public goods are those goods or services that provides non excludable and non rival benefits to all people in the population.
🔷 Few example of pure public goods : public fireworks , lighthouses , clean air and other environmental goods, fresh air , National defence , flood control systems and Street lightning.
Q14) what is impure public goods?
🔷 impure public goods are many hybrid goods that possess some features of both public and private goods.
🔷 They are partially rivalrous or congestible.
🔷 Few example of impure public goods :
(a) open access Wi-Fi networks become crowded when more people access it.
(b) the use of cable television by other individuals will in no way reduce your enjoyment of it. the good is excludable since the cable TV service providers can refuse connection if you do not pay for set top box and recharge it regularly.
🔷 The possibility of exclusion from the use of an impure public good as two implications :
(i) since free riding can be eliminated , the impure public good may be provided either by the market or by the government at a price or free.
(ii) the provider of an impure public good may be able to control the degree of congestion either by regulating the number of people who may use it , or the frequency with which it may be used or both.
🔷two broad classes of goods have been included in the studies related to impure public goods :
(i) club goods: first studied by Buchanan
(ii) variable use public goods: first analysed by Oakland and sandmo
Examples of club goods are facilities such as swimming pool , fitness centres.
Examples of variable public goods are facilities such as roads , bridges.
Q15) what is Quasi public goods ( mixed goods )?
🔷 The quasi-public goods or services, also called a near public good (for e.2 education, health services possess nearly all of the qualities of the private goods and some of the benefits of public good.
🔷It is easy to keep people away from them by charging a price or fee.
🔷However, it is undesirable to keep people away from such goods because the society would be better off if more people consume them.
🔷This both characteristic namely, the combination of virtually Infinite benefits to society and the ability to charge a price results in some quasi public goods being sold through markets and others being provided by government.
-🔷Example No.1 For example, if one gets inoculated against measles it confers not only a private benefit to the individual, but also an external benefit because it reduces the chances getting infected of other persons who are in contact with him.You can observe here that the external effect associated with the consumption of a private good may have the characteristics of a public good.
🔷Example No.2: Education will improve the Individual’s earning potential and at the same time. It may facilitate basic research policy recommendations that you may be able to put forth for a better tax or budgeting system which are public goods.
🔷Markets for the quasi public goods are considered to be Incomplete markets and their lack of provision by free markets would be considered as Inefficiency and market failure.
Q16) what is common access resources ? why are they overused ? / describe the term ‘ tragedy of commons ‘ ?
🔷 common access resources aur common pool resources are a special class of impure public goods.
🔷 These are non excludable as people cannot be excluded from using them. These are rival in nature and their consumption lessens the benefits available for others.
🔷this rival nature of common resources is what distinguishes them from pure public goods, which exhibit both non excludability and non rivalry in consumption.
🔷 They are generally available free of charge.
🔷 Examples of common access resources are fisheries , common pastures , rivers , sea , backwaters , biodiversity . The earth’s atmosphere is perhaps the best example. emissions of carbon dioxide and other greenhouse gases have led to the depletion of the ozone layer endangering environmental sustainability.
WHY ARE THEY OVER USED?
🔷since price mechanism does not apply to common resources , producers and consumers do not pay for these resources and therefore , they over use them and cause their depletion and degradation. This creates threat to the sustainability of these resources and , therefore , the availability of common access resources for future generation decreases.
🔷economist use the term tragedy of the commons to describe the problem which occurs when rivalrous but non excludable goods are overused , to the disadvantage of the entire world.
Q17) what is global Public goods?
🔷 there are several public goods benefits of which accrue to everyone in the world.
🔷these goods have widespread impact on different countries and regions , population groups and generations.
🔷 These are goods whose impacts are individually spread throughout the entire world.
🔷the WHO stated two categories of global Public goods namely, final public goods which are ‘outcomes’ , and intermediate public goods, which contribute to the provision of final public goods.
🔷 similarly, the World bank identifies five areas of global Public goods which it seeks to address : namely ,
a) the environmental commons
b) communicable diseases
c) international trade
d) international financial architecture
e) global knowledge for development
🔷The distinctive characteristic of global Public goods is that there is no mechanism to ensure an efficient outcome.
