Chapter 14: Market Failure Flashcards
Market failure
Market forces resulting in an inefficient allocation of resources.
If left to market forces, some products may be under-produced, some over-produced and some may not be produced at all. Prices may be high due to lack of competitive pressure and difficulties in lowering the costs. A lack of investment and reduction in expenditure on research and development, can also slow down the improvement in products
Third parties
Those not directly involved in producing or consuming a product.
Social benefits
The total benefits to a society of an economic activity
Social costs
The total costs to a society of an economic activity.
Private benefits
Benefits received by those directly consuming or producing a product.
Private costs
Costs borne by those directly consuming or producing a product.
External costs
Costs imposed on those who are not involved in the consumption and production activities of others directly
External benefits
Benefits enjoyed by those who are not involved in the consumption and production activities of others directly.
Socially optimum output
The level of output where social cost equals social benefit and society’s welfare is maximized.
Market failure: Information failure
There may be a lack of information or inaccurate information. There may also be asymmetric information which occurs when consumers and suppliers do not have equal access to information.
Market failure: Merit goods
Products which the government considers consumers do not fully appreciate how beneficial they are and so which will be under-consumed if left to market forces. Such goods generate positive externalities.
Market failure: Demerit goods
Products which the government considers consumers do not fully appreciate how harmful they are and so which will be over-consumed if left to market forces. Such goods generate negative externalities.
Market failure: Public goods
A product which is non-rival and nonexcludable and hence needs to be financed by taxation.
Market failure: Private goods
A product which is both rival and excludable.
Market failure: Abuse of monopoly power
Producers having more market power than consumers. If one firm dominates a market, it may not be allocatively, productively or dynamically eff icient. It will lack competitive pressure to respond to consumer demands, to keep its costs low and to improve its product. If it is the only firm selling the product, that is a monopoly: consumers will have no choice but to buy from it, even if the price of the product is high, the product does not meet the needs of the consumers and its quality is poor
Price fixing
When two or more firms agree to sell a product at the same price.
Market failure: Immobility of resources
To achieve allocative efficiency, it is necessary for resources to move from producing products that are decreasing in demand towards those which are experiencing an increase in demand. This requires resources to be both occupationally and geographically mobile. In practice, some resources may be immobile. If, for example, demand for a country’s financial services might be increasing, whilst demand for its steel may be decreasing, there may be a shortage of financial services, unemployment of workers and under-utilisation of capital equipment if resources cannot easily move between the two.
Market failure: Short termism
There is a risk that market forces may not result in suff icient resources being devoted to capital goods. If a country produces a high quantity of consumer products, people can enjoy a high living standard. For them to enjoy more consumer products in the future, some resources have to be diverted for making capital goods. Private sector firms may be interested in making quick profits and may not plan for times ahead. Such a short-sighted approach can result in a lack of investment. As a result, a government may have to stimulate private sector investment by, for example, cutting taxes on firms and undertake some investment itself. S
