Chapter 10 - Market Failure Flashcards
what is a market failure
a market failure in economics occurs when a free market doesn’t allocate resources efficiently leading to outcomes that are not in the best interest of society.
market failure - when the price mechanism in a market leads to an inefficient allocation of resources.
in other words, the market doesn’t work perfectly on its own through the price mechanism, and there’s a need for some form of intervention to improve this situation.
what are examples of market failure ?
negative externalities & demerit goods
-externalities are unintended side effects of economic activities that impact third parties who are not involved in the transaction
- for instance, pollution from factories affects air quality and public health, which is a negative externality.
-the market may not consider the costs imposed on others ( private cost, social costs, financial costs ), leading to the overproduction or overconsumption of a demerit good.
what are externalities positive or negative ?
a cost or benefit is incurred or received by a 4rd party who did not engage in the activity ( production or consumption)
it can occur from the production or consumption process that effects individuals who are not directly involved in the process
eg pollution from a factory harming local water sources
eg one homeowner renovation their home increasing the value of the homes in the area
what is a demerit good ?
a good where
- positive effects are overestimated by consumers and which have
-negative effects which consumers underestimate or are unaware of
-demerit goods usually also have negative externalities i.e. they have negative effects on third parties not involved in the consumption of the good.
eg smoking is seen as a demerit good/market failure as it leads to the overconsumption of a harmful good, and has negative externalities ( passive smoking, higher healthcare costs )
what is a public good ?
these are goods that are non- excludable and non- rivalrous, meaning that once provided, no one can be excluded from using them, and one person’s use doesn’t diminish its availability to others.
eg clean air, playgrounds and street lighting
since people cant be excluded from benefitting, the private market might underprovide these goods as businesses can’t easily charge for their usage
what is a free rider problem ?
a “ free rider” problem occurs when some users overuse a shared resource, or don’t pay or contribute their fare share for a resource.
what is information asymmetry (incomplete information) ?
this occurs when one party in a transaction has more or better information than the other, leading to an imbalanced decision making
eg in used car sales, the seller often knows more about the car’s condition than the buyer
this can lead to the sale of poor quality goods or services, causing inefficiency.
eg when a person takes out health care. only the buyer knows their actual health risks, and if they lie and need pay-outs/ compensation, this can lead to higher premiums for everyone getting health insurance.
market failure - monopolies and oligopolies (higher monopoly power) what is it ?
market power is the ability of a firm to influence the price of a good
in markets with a lack of competition, a single company or a small group of companies( oligopoly) may have significant control over prices and output
monopolies and oligopolies can lead to higher prices, reduced choice and hinder innovation, as there’s less incentive to improve when competition is limited,
what is income inequality ?
if the distribution of income and wealth in highly uneven, some members of society may not have the purchasing power to access basic needs and opportunities
this can lead to inefficiencies, as potential consumers can’t afford to buy goods and services, limiting overall economic growth
how market failures can be overcome - taxation
- negative externalities- when negative externalities like pollution occur, governments can impose taxes or levies on activities that generate these external costs. For example, a carbon tax on industries emitting greenhouse gases can incentivise them to reduce pollution by making it more expensive to pollute.
-demerit goods- taxes can be placed on goods with negative social effects, like tobacco and alcohol. these “sin taxes” discourage consumption and generate revenue that can be used for public health programs or awareness campaigns.
how market failures can be overcome - regulation
externalities - governments can set regulations and standards to limit harmful externalities. for instance, emission standards for vehicles or restrictions on industrial waste disposal can help control pollution
information asymmetry - regulations can require businesses to provide accurate and transparent information to customers. this helps overcome information asymmetry and empowers consumers to make informed choices. examples include nutritional labelling on food products or safety requirements for pharmaceuticals
how market failures can be overcome - direct government intervention
public goods - since public goods are often underprovided by the private market, governments can directly provide or subsidize them. For instance, governments build and maintain public parks, roads and national defence infrastructure.
market monopoly - in cases of natural monopolies , where its most efficient for one provider to serve the entire market, governments can regulate prices and ensure fair access. Alternatively, governments might choose to nationalize certain industries to ensure competitive pricing and quality services
how market failures can be overcome - subsidies and incentives
-positive externalities - to promote positive externalities like education and research, governments can provide subsidies or grants
eg offering subsidies to renewable energy companies can encourage their growth and adoption
-merit goods - governments can provide subsidies to encourage consumption of merit goods like healthcare and education, ensuring that essential services are accessible to everyone
how market failures can be overcome - redistribution of wealth and income
income inequality -through taxation and social welfare programs, governments can redistribute income and wealth to ensure a more equitable distribution.
this can improve access to basic necessities and promote social sustainability
eg use progressive taxes to take proportionately more from higher income earners
what is a moral hazard ?
this refers to the lack of incentive an individual or firm may have to safeguard against risk if they are protected against the consequences of the risk incurred. it involves hidden actions , when one party takes action that the other party cannot observe but which will affect them both
an individual who insures their mobile phone may be more careless with the device once insurance cover is in place
if banks feel that they will be bailed out by a government rather than fail , it may encourage them to take risks that they would otherwise would not take
a moral hazard is not a market failure, but can lead to problems within a market
