Chapter 1.5 - Market Failure

Question 0

List 6 reasons for market failure.

Answer 0

1. Immobility of labour
2. Public goods
3. Positive and negative externalities
4. Price instability in commodity markets
5. Asymmetric information
6. Government failure

Question 1

Define ‘market failure’.

Answer 1

Market failure occurs when the market forces do not result in the efficient allocation of resources.

Question 2

What is necessary for resources to be allocated efficiently?

Answer 2

It is necessary for social marginal costs (SMC) to be equal to social marginal benefits (SMB).

Question 3

Define ‘social marginal costs (SMC)’.

Answer 3

SMC refers to the addition to total cost of producing an extra unit of output.

Question 4

Define ‘social marginal benefits (SMB)’.

Answer 4

SMB refers to the addition to total benefits of consuming an extra unit.

Question 5

Define ‘immobility of labour’.

Answer 5

Immobility of labour refers to limitations on the ability of workers to move between different parts of the county or between occupations.

Question 6

Identify and define the 2 types of immobility of labour.

Answer 6

1. Geographical immobility of labour - this refers to the limitations on the ability of workers to move from one part of the country to another.
2. Occupational immobility of labour - this refers to limitations on the ability of workers to move from one occupation to another.

Question 7

What are the 4 causes of geographical immobility of labour?

Answer 7

1. Differences in regional house prices - a person living in an area of relatively low house prices will find it difficult to move to an area where house prices are much higher.
2. Cost of moving house - these include removal costs, legal costs and taxes.
3. Social and family ties - some people may be reluctant to move away from an area because they have family and friends in the area and/or have other links to the area.
4. Disruption of children’s education - parents may be unwilling to move to a different part of the country as it means that their children must change schools.

Question 8

What are 4 measures to increase the geographical mobility of labour?

Answer 8

1. Housing subsidies - e.g. aren’t subsidies or housing benefit.
2. Provision of affordable housing - the government may build new homes for those on low incomes or provide a scheme where the buyer has a part-share in the ownership of the house.
3. Reduction in planning restrictions so that it is easier for developers to build new homes.
4. Improvement of information about job availability in other parts of the country (e.g. through the internet).

Question 9

What are the 4 causes of occupational immobility of labour?

Answer 9

1. Lack of relevant skills - unemployed workers may be unable to secure jobs because they don’t have the skills required to take the jobs available.
2. Lack of appropriate qualifications - for some jobs a specific qualification may be required.
3. No relevant experience - some employers insist on the need for experience in the occupation before employing a worker.
4. Wage rate - a worker may not wish to move to another job if the wage rate is too low.

Question 10

What are 3 measures to increase the occupational mobility of labour?

Answer 10

1. Training programmes - these would be aimed at closing skills shortages by providing appropriate courses.
2. Increase higher education provision - graduates may have transferable skills so that they can be trained quickly and easily to work in different jobs.
3. Information about opportunities in other occupations - workers may not be aware of the possibility of pursuing an alternative career.

Question 11

Define ‘public goods’.

Answer 11

Public goods are goods that are non-rivalrous (amount available does not fall after one person’s consumption) and non-excludable (cannot prevent anyone from consuming them), e.g. street lights, national parks.

Question 12

What is the free rider problem?

Answer 12

The free rider problem is the problem that once a product is provided, it is impossible to prevent people from using it and, therefore impossible to charge for it.
This is a problem because in such circumstances the market will fail: an insufficient number of people will be willing to pay and it will not be profitable for a business to provide it.

Question 13

Explain the government policy to correct the market failure caused by the free rider problem.

Answer 13

The usual policy response is for the government to provide public goods financed through taxation.
Disadvantage: ultimately politicians will determine the amount of resources allocated to these public goods without direct reference to the electorate.

Question 14

Name 2 alternative methods of providing some public goods.

Answer 14

Alternative methods of providing some public goods could be by agencies appointed by the government (known as ‘contracting-out’) or by charities and voluntary organisations.

Question 15

Define ‘externalities’.

Answer 15

Externalities are costs and benefits to third parties who are not directly part of a transaction between producers and consumers.
They are, in effect, spillover effects arising from the production or consumption of a good or service which are not considered by the price mechanism.

Question 16

State the 2 types of externalities and explain why are they a form of market failure.

Answer 16

Externalities are a form of market failure because market forces will not result in an efficient allocation of resources - two types:

1. Negative externalities
2. Positive externalities

Question 17

Define ‘negative externalities’.

Answer 17

Negative externalities are costs to third parties - i.e. other than the producer or consumer directly involved in the transaction.
They are spillover costs from the production and consumption which the market fails to consider.

Question 18

Define and give 3 examples of external costs.

Answer 18

External costs are the costs in excess of private costs which affect third parties who are not part of the transaction. External costs of production include:

1. air pollution (e.g. noxious gases from a factory)
2. noise pollution (e.g. construction work or machinery used in production)
3. pollution arising from the destruction of the rainforest to grow crops

Question 19

Define and give examples of private costs.

Answer 19

Private costs are the direct costs to producers and consumers for producing and consuming a product.

1. Private costs of a producer: e.g. wages, rent, raw materials, energy.
2. Private costs for a consumer: price paid for the product.

Question 20

Complete the following formulae:

Social costs = _ _ _ _ _ _ _ costs + _ _ _ _ _ _ _ _ costs

Answer 20

Social costs = private costs + external costs