Chapter 14: Market failure

Question 1

Market failure

Answer 1

When market forces fail to produce the products that consumers demand, in the right quantities, and at the lowest possible cost

Question 2

Failure to take into account of all costs and benefits

Answer 2

• Overallocation of goods that firms only think about private costs of and does not take into account for external costs
• Underallocation of goods that firms do not consider the external benefits of

Question 3

Information failure

Answer 3

• Consumers need to be fully informed about a good or service to make the right consumption decisions
• Workers need to know information about their jobs
• Producers need to know what products are in demand, where good quality raw materials can be purchased at low prices, and what the most cost effective way of production is
• If they lack information, they will make decisions that are not in their best interests
• Consumers and suppliers do not have equal access information

Question 4

Merit goods

Answer 4

• Products that are beneficial to the consumers
• Failure to acknowledge true value means that these products would be under consmerd and under produced if left to market forces

Measures:
- Providing information on the benefits
- Subsidies lead the price to fall, increasing demand
- May provide product free or make it compulsory

Question 5

Demerit goods

Answer 5

• Products more harmful to consumers than they realise and generate external costs
• Over consumed and over produced if left to market forces

Measures:
- Government could raise price by imposing a tax
- Information campaigns about harmful effects
- Ban the product

Question 6

Public goods

Answer 6

• Public goods are non rivalry
• Non rejectable
• Cost of supplying a public good to one more consumer is 0
• Markets will not supply public goods
• Has to be financed through taxation
• Government can produce them or pay a private sector company to produce them

Question 7

Abuse of monopoly power

Answer 7

• Market failure from producers having more market power
• One company dominates market
• Lack of competitive pressure to respond to demand to keep costs low and improve its product
• Lack of choice

Measures:
- Removing restrictions on the entry of new firms into a market
- Stop some firms from merging

Question 8

Immobility of resources

Answer 8

• Necessary for resources to move from producing products that are decreasing in demand towards those which are increasing in demand
• If resources are immobile, markets may not be able to move resources to their most efficient use

Measures:
- Improve education and provide training to promote occupational mobility
- Governments can provide investment grants to make it easier for firms to change the use of land and buildings to promote occupational mobility
- Encouraging geographical mobbility by making it easier to buy or rent housing in areas where demand for labour is high
- Construction of more houes or financial help for those workers who move to these locations

Question 9

Short termism

Answer 9

• Risk that market forces may not result in sufficient resources being devoted to capital goods
• For people to enjoy a higher living standard in the future, some resources have to be diverted for capital goods
• Private sector firms may be interested in making quick profits and not plan ahead - result in lack of investment

Measures:
- Government stimulate private sector investment by cutting taxes and undertaking some investment itself