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Economics IB HL > Chapter 11: Market Failure > Flashcards

Chapter 11: Market Failure Flashcards

1
Q

What is Market failure

A

price mechanism allocates scarce resources inefficiently-> Loss in economic welfare.

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2
Q

Outcomes of market failure?

A

Under/over provision of certain products
Under/over consumption of certain products

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3
Q

Why does MF occur?

A

divergence between private costs and benefits, as well as social costs and benefits of production/consumption

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4
Q

External benefits/positive externalities

A

Advantages/gains of production/consumption to a third party (not involved in economic transaction)

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5
Q

External Costs/negative externalities

A

Disadvantages incurred by a third party in an economic transaction, compensation not paid

(spillover effects).

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6
Q

Private benefits

A

Advantages/gains of production/consumption enjoyed by an individual firm/person.

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7
Q

Private costs

A

PC of production/consumption are actual expenses incurred by a individual firm/person.

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8
Q

Social benefits

A

True benefits of consumption/production, sum of private and external benefits.
Social benefits = private benefits + positive externalities.

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9
Q

When does socially optimum output occur?

A

When marginal social benefit = marginal social cost (MSB = MSC output level)

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10
Q

Marginal Private benefit

A

Additional value enjoyed by stakeholders from consumption/production of an extra unit of particular product

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11
Q

Marginal private cost

A

Additional Expense of production for firms/extra charge paid by consumers for output/consumption of extra unit of product.

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12
Q

Marginal social benefit

A

total gain to society from extra unit of production/consumption (sum of benefits)

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13
Q

Marginal social cost

A

total expenses to society from an extra unit of particular product (cons/prod)

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14
Q

Allocative Efficiency

A

When social surplus is maximized.
socially optimum level of output MSB = MSC
not possible to reallocate resources to make one party better off without making others worse.

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15
Q

Social Surplus

A

Sum of CS and PS at a given market price. Net benefit available to society from economic transaction.

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16
Q

When is social surplus maximized?

A

Maximised when market is cleared by PM. No shortages/surpluses. Maximising social welfare

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17
Q

Negative Externalities/spillover effects

A

are the external costs of an economic transaction, causing the
market to fail to achieve the social optimum level of production or consumption

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18
Q

Positive externalities

A

benefits enjoyed by third party not directly involved.

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19
Q

Merit Goods

A

products that create positive externalities when produced/consumed. MSB > MPB (prod/cons)
deemed of value due to spill over effects on third parties, impacting social welfare. improves SOL in economy.

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20
Q

Characteristics of merit good

A

Rivalrous
Excludable
Tend to be underconsumed+produced in FM conditions.

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21
Q

what does rivalrous mean

A

consumption reduces amount available to others at that point in time

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22
Q

excludable

A

possible to prevent non-payers benefitting from merit good

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23
Q

Draw a graph of positive externalities of consumption (of merit goods)

A
  • MSB > MPB
  • positive consumption externalities exist at all levels up to socially optimal level of output as a result
  • MF (at FM equilibrium) underconsumption of merit good
  • MSB = MSC socially desirable level
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24
Q

Draw a graph of positive externalities of production (of merit goods)

A

MPC > MSC
- true for all levels of production, till (MSC = MPB)
- vert distance MPC and MSC shows existence of positive externalities
- hence MF at equilibrium
- underconsumption of merit good
intervention needed to lower price to encourage consumption

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25
Q

Demerit good

A
  • products that create negative spillover effects
    to third parties not directly involved.
  • can be damaging, production/consumption = MSC > MPC
  • overproduced/consumed
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26
Q

Graph of negative externalities of production (Of demerit goods)

A

MSC>MPC (due to harmful effect when producing)
without intervention, output Qe (MPC = MPB of production)
socially opt is qopt
society deems there is overproduction welfare loss
benefits if output reduced, eliminate externalities

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27
Q

Graph of negative externalities of consumption (Of demerit goods)

A

MSB < MPB (due to harmful effect when consuming)
Without intervention, Qe, exceeds qopt (at MSC = MSB of consumption)
society deems overconsumption + welfare loss
society benefits if consumption reduced to qopt (eliminates externalities)

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28
Q

What are common pool/access resources?

A

Non-excludable but rivalrous in consumption and create tragedy of the commons, they result in negative externalities and unsustainable production. (pastures, rivers, atmosphere)

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29
Q

Non excludability in terms of CPRs

A

CPRs are freely available - tends to be overconsumed.
Difficult to sustain, hence require intervention to prevent depletion

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30
Q

Rivalrous in terms of CPRs

A

usage reduces amount available for others to consume.
consumption diminishes quantitiy and possibly quality of remaining resources for current and future generations
generations may be deprived

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31
Q

Tragedy of the commons

A

Degradation, depletion of a common pool resource caused by problems of rivalry and overuse.

exploitation of CPRs leads to unsustainable production and negative externalities.

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32
Q

Different methods to intervene in response to externalities and common pool resources (PIGLETS CC)

A

Pigouvian taxes
International agreements
Government provision
Legislation and regulation
Education (awareness creation)
Tradable permits
Subsidies

carbon taxes
collective self governance.

33
Q

Pigouvian taxes

A

corrective measure “internalize” negative externalities. reduce/eliminate
pay true costs of their actions (buyer/seller)
without intervention no incentive for concern for external costs.

34
Q

Draw a graph of a Pigouvian tax being implemented on a firm

A

-firm causes divergence between MPC and MSC
- Pigouvian tax objective, make price equal to D MSB. create more socially efficient allocation of resources.
- raises cost to producer, S = MPC curve shift leftwards towards S2 = MSC
- price -> Popt
- Qd -> Qopt
- A = free market equilibrium
- B socially optimal lvl output

35
Q

Advantages of imposition of Pigouvian tax on production/consumption of products with negative externalities

A
  • increases price so should decrease qd
  • creates tax revenue for gov, can be used to raise public funds to deal with externalities or other measures.
36
Q

Disadvantages of imposition of Pigouvian tax on production/consumption of products with negative externalities

A
  • demand for such products is inelastic, little impact on level of consumption
  • tax on these products is regressive, > impact on low income
  • can encourage unofficial market activities (parallel market, smuggling)
37
Q

Carbon taxes

A

tax on greenhouse gas emissions/carbon content of fossil fuels to reduce pollution from particular industries by internalizing negative externalities of production
- creates incentive to reduce pollution
- without tax, Mf exists as firms are not accurately charged for fossil fuel use.

38
Q

Diagram of Carbon tax on polluting firms

A

Factory polluting creates divergence between MPC and MSC of production
- effectm of per unit carbon tax (Popt - P0) is fall of production to Qopt
and a higher price
tax rev earned shown by green area

39
Q

Advantages of carbon tax

A
  • impose additional costs to users of carbon fuels, pay for damage caused by their economic activities
  • an effective carbon tax makes it more economically rewarding to switch to alternative fuels
40
Q

Disadvantages of carbon tax

A
  • correct tax rate is key to effectiveness
  • too low, continue to pollute
  • too high, escalated costs negatively affect profits, employment and consumers.
  • effectiveness depends on ability to pass on higher energy costs to consumers
  • inelastic? consumers bear greater proportion
  • regressive, account for larger proportion of income of poorer households.
  • higher income households, switch to energy efficient.
41
Q

Legislation

A

Laws stipulated by government on the use of scarce resources

42
Q

Regulation

A

Act of monitoring and controlling activity of firms, management of complex rules, laws policies.

43
Q

How can laws be used in the case of merit goods/demerit goods

A

Can be used to encourage consumption of merit goods or reduce consumption/production of demerit.

44
Q

Draw a diagram for Legislation and Regulation of Negative consumption externalities

A
  • demand curve for demerit good shifts from MPB to MSB, due to reduced benefits of consumption
  • consumption -> Q1 to Qopt
  • reducing/eliminating negative externalities associated
  • illegal markets can develop + people may choose to break rules/regulations
45
Q

Limitations of Legislation and Regulation

A
  • parallel markets develop, where demerit product is purchased, high price
  • unless penalties are high +enforced, consumers may choose to break rules.
46
Q

Education - awareness creation

A

Educating public, costs of consuming demerit goods/benefits of consuming merit goods to correct MF.
- more socially desirable outcomes

47
Q

Diagram for education - awareness creation (vegetables and fruits e.g) positive consumption externaliites

A

-outward shift , MPB to MSB, consumption, Qm to qopt
- healthier people, fewer absences, benefits society
- costs for funding education, does not translate to CS/PS + administrative costs, DWL.

48
Q

Advantages of education (awareness creatrtion) to combat problems of market failure

A
  • behaviour/consumption patterns may change, rise in consumption of merit, fall in demerit
  • successful advertising can lead to cultural change in behaviour, e.g healthier diets.
49
Q

Disadvantages of education (awareness creation) to combat problems of market failure

A
  • not all campaigns are effective, does not necessarily work
  • time lags in educating, and to be acted upon
  • opportunity cost of government expenditure. Could be spent on something more beneficial to society
50
Q

Tradable permits (Cap and trade schemes)

A

government regulated emissions trading schemes, limit pollution in industry to more socially efficient level.
can sell any excess permits.
- incentive to change to cleaner technologies.

51
Q

advantages of tradable permits (cap and trade schemes)

A
  • can raise a significant amount of revenue for the government.
  • due to economic growth, demand for pollution permits increase, but cap on pollution creates higher prices for tradable permits.
52
Q

diagram of tradable permits when demand for them increases

A

Increased demand for permit, shifts market price
supply capped by gov, no change
polluters pay for external costs
rev goes from 0,P1,A,Qe to 0,P2,B,Qe (increased)

53
Q

Effect of tradable permits on large polluters

A
  • largest polluters need more permits
  • increased costs, less competitive + profitable
54
Q

Effect of tradable permits on environmentally friendly producers

A
  • gain extra rev from selling permits (surplus)
  • making them more competitive+profitable
55
Q

Effects of a government over time choosing to reduce number of pollution permits

A

gov may chose to reduce, shift to left (supply)
- raises price
- greater incentive to be more efficient (clean tech)

56
Q

Critiques of CATS

A

Argued it is anti competitive (smaller firms) = job losses (higher costs)
MNCs shift production elsewhere
argued higher prices of permits are ineffective to stop global warning (demand is highly price inelastic)
cap is deemed too high

57
Q

International Agreements

A

governments can create international agreements in response to negative externalities
- most are legally binding (treaties) ->makes countries accountable

58
Q

Bilateral agreements/multilateral

A

Agreements between two countries/more

59
Q

Effects Of international agreements:

A

Implementation recognises countries that are higher income have more responsibility in playing a role to combat negative externalities (e.g global warming)

60
Q

Critiques of International agreements

A

Require full commitment from all countries. Unwillingness undermines international agreements purpose.
High income countries/MNCs exploit low income countries, despite agreements
e.g deforestation

61
Q

Collective Self Governance (local communities allocate use of resources)

A

Voluntary communal actions to tackle negative externalities and problems associated with exploitation of CARs

62
Q

Why the need for collective self governance?

A

-Local communities make more informed decisions.
-Knowledge about local culture
-directly affected
-often reliant, taxation+education.
- creates socio-economic benefits for communities. employment + higher income

63
Q

Subsidies

A

Financial assistance, gov to local firms, lower costs of production to help compete against foreign imports.
- encourage output, lower price, lower cost of living for citizens.

64
Q

Diagram of Subsidies

A
  • shown by vert distance, represents value of +ve ext
  • reduced production costs, (s) shifts outwards to MSC
  • consumers gain lower prices (Pm to Popt)
  • producers keep remainder (lower prod costs, P0 to Pm)
  • incentive to consume good (quantity)
  • amoutn spent, shaded area
65
Q

Welfare analysis of Subsidies graph

A
  • administrative costs of provision + funding for subsidies do not equate to additional CS/PS
  • Price was Pe, CS was A+B (Prior)
  • PS was E + I
  • After Price falls to Pc, CS increases to ABEFG
  • producers, receive price of Pp, Ps is B+C+E+I
  • total amount spent shown by shaded yellow area
  • D + H = DWL
66
Q

Limitations of Subsidies to correct MF

A
  • difficult to set precise subsidy, for optimal allocation of resources
  • social return for merit goods is difficult to measure
  • if PED of product is inelastic, lower price, little impact
  • always opportunity cost, could’ve spent on projects reaping greater social gains.
67
Q

Government provision

A

Direct provision of products, final gov response to MF, ensures optimal level of output achieved
- market fails to provide adequate supply of merit/public goods

68
Q

Advantages of Government provision

A

merit/public goods accessible to everyone regardless of status
- improves wellbeing of society

69
Q

Limitations of Government Provision

A
  • may encourage consumption beyond socially optimum level, likely to overuse.
  • entails an opportunity cost, money could be spent paying off debt etc.
  • difficult to decide who can take advantage of subsidized product (when there is excess demand)
70
Q

What are the challenges involved in measurement of externalities?

A
  • what is the value of an externality, can they be measured precisely?
  • challenges in measuring impact of an externality does not mean government can ignore it.
71
Q

What is the degree of effectiveness of government intervention?

A
  • not always clear if intervention clears MF effectively.
  • many factors affect consumption of merit/demerit goods. cannot use ceteris paribus
  • policies limited by time lags and costs of enforcement/cost of government provision
  • value judgements influence use of certain policies to deal with Mf
  • disagreements will occur between policymakers, economists from diff schools of thoughts, poltiicians
72
Q

What are the consequences for stakeholders (MNCs and Lower income firms) affected by government intervention

A
  • MNCs relocate to low income countries, limits are not imposed/controlled, same extent
  • legislation/regulation favour MNCs that have financial resources to comply, smaller firms, higher cost of compliance, struggle
  • Pigouvian taxes, regressive, impactful on low income earners/smaller firms. Minimal impact on spending behaviour
73
Q

Importance of International Cooperation

A

vital due to demand for scarce resources
- requires consideration, global nature of sustainability issues
- challenges faced in international cooperation
- need for monitoring and enforcement.

74
Q

Global nature of sustainability issues

A
  • governments need to consider ecological/social sustainability than just economic
  • SDGs (UN) widely used framework
  • address global challenges to sustainability, caused by MF
  • debate on how much needed to achieve 17 goals.
75
Q

Challenges faced in International Cooperation

A
  • cultural differences, contexts, challenges.
  • laws differ in countries (alcohol/cigarette age)
  • may generate huge tax revenues in countries, e.g China, Russia
  • reluctant to comply with ban
  • debate, how much should countries contribute to tackling problems.
76
Q

Monitoring and Enforcement

A

Enforcing policies used to correct MF

77
Q

Monitoring and Enforcement examples

A
  • regulate where to drive, cycle gamble
  • smoking being illegal
  • eat/talk on phone while driving
  • passengers, seatbelts.
78
Q

Limitations of Monitoring and Enforcement

A
  • Financial+opportunity costs
  • no control over quality of products in parallel markets
  • can be dangerous
  • may still break rules, fines not high enough to discourage, laws not enforced

Economics IB HL (16 decks)

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