Chapter 2.10 Market failure Flashcards
When does market failure occur (broadly)
When market forces fail to produce the products that consumers demand in the right quantities and at the lowest possible cost - inefficiency
What are the types of market failure?
- failure to take into account
all costs and benefits - information failure
-Merit goods
-Demerit goods
-Public and private goods
-Abuse of monopoly power
-immobility of resources
-short termism
What does failure to take into account all costs refer to?
Market failure occurring because the firm only considers their private costs, they ignore the external costs.
This means the external costs are not paid for by anyone.
If the FULL cost (social costs) had to be paid, firms would produce much less
What are private costs?
costs borne by those directly consuming or producing a product
What are external costs? examples?
Costs imposed on those who are not involved (third parties) in the consumption and production activities of others directly.
e.g Air pollution from factories
Industrial waste in rivers
define third parties
Those not directly involved in producing or consuming a product
Define social benefits
the total benefits to a society of an economic activity
Define private benefits
Benefits received by those directly consuming or producing a product.
What is usually imposed on third parties
significant external costs
What is the total cost to society from production of a good?
the private costs + external costs
The firm produces ________ because they only think about their private costs
more
The firm produces more because they only think about their __________
private costs
Firms should produce _______ because they should consider the external costs too.
less
Firms should produce less because they should consider the _________ too.
external costs
What does failure to take into account the external cost of a good lead to
the inefficient overallocation of this good
What does the failure to account all benefits refer to?
Individuals only
Define external benefits and give examples
benefits enjoyed by those who are not involved in the consumption and production activities of other directly
e.g:
Education → A well-educated workforce leads to higher productivity and economic growth, benefiting society.
Public transport → Reduces traffic congestion and pollution, benefiting all road users.
What is socially optimum output?
The level of output where social cost equals social benefit and society’s welfare is maximised
How is full social benefit represented on a graph?
Original demand curve- private benefit
The demand curve shifted right- full social benefit
Price moves up and is labelled pso (socially optimum
Original price is labelled pfm (free market)
same with Qfm
supply extends due to increased price
How is full social benefit represented on a graph?
Original demand curve- private benefit
The demand curve shifted right- full social benefit
Price moves up and is labelled pso (socially optimum
Original price is labelled pfm (free market)
same with Qfm
supply extends due to increased price
How is full social cost represented on a graph?
Supply is shifted to the left (full cost)
Original supply (private cost)
Price is increased if S is shifted to the left (labelled Pso)
Og price is labelled pfm
Quantity is decreased to Qso
og quantity is labelled Qfm
The consumer consumes ________ because they only think about their private benefit
less
The consumer consumes less because they only consider their _________
private benefit
They SHOULD consume __________ because they should consider the external benefit too
more
They SHOULD consume more because they should consider the __________ too
external benefit
What does failure to take into account external benefits lead to?
inefficient underallocation of this good
Define and explain demerit goods
Goods that are harmful to the consumer and/or wider society.
People don’t know, underestimate or ignore the harm it causes to themselves and society
These goods generate external costs and will be over-consumed and over-produced if left to market forces.
e.g cigarettes, junk food, drugs
Whats an example of a demerit good having an external cost?
Smoking cigarettes not only harms the smoker’s health (private cost) but also imposes external costs on third parties:
Secondhand smoke affecting non-smokers
Healthcare costs burdening taxpayers and public health systems.
Littering from cigarette butts
Define and explain merit goods
These are goods that are beneficial to the consumer and/or wider society
People don’t know, underestimate or ignore the good it brings to themselves and society
Consumers tend to UNDERCONSUME these goods
e.g contraception, education, healthcare
What is an example of a merit good being underconsumed?
People may underconsume vaccines because they ignore the external benefits
If too many people avoid vaccination, diseases can spread, causing higher healthcare costs and outbreaks.
How does lack of information lead to market failure?
consumers need to be fully informed about a good or service to make right decisions
in a market where the producer/seller is an ‘expert’ and a consumer is not familiar, the consumer might be encouraged to buy or pay too much for a product
e.g car mechanics services, technology, insurance
Why might information failure be a problem in labour markets?
An employer may lack information about struggles an employee may face in their jobs
an employee may lack info about the job itself.
This can lead to misallocation of labour and contributes to underemployment, job dissatisfaction, and productivity losses
What are public goods?
A public good is a product which is non-rival and non- excludable and hence is not provided in a free market economy
e.g national defence, police services, infrastructure
Why does the free market fail to provide public goods?
The free rider problem and the lack of profit incentive for firms:
Since firms cannot make money from public goods, they won’t produce them, leading to market failure- a lack of a market in this case.
What does non-excludable mean?
A good is non-excludable if people cannot be prevented from using it, even if they don’t pay.
Example: Street lighting → Once installed, everyone benefits, even those who don’t contribute.
What is the free rider problem?
The free rider problem occurs when people benefit from a good or service without paying for it and so nobody is willing to buy it, leading to no production in a free market.
What does non-rivalry mean
A good is non-rivalrous if one person’s use does not reduce its availability for others.
Example: Street lighting → One person using it doesn’t stop others from benefiting.
How does immobility of resources lead to market failure
If resources, especially labour, are geographically or occupationally immobile, markets may not be able to move resources to their most efficient use.
Whats an example of immobility of resources?
-lack of skills (occupational immobility)
-High house prices- (geographical immobility)
-Poor transport
What is a monopoly?
A monopoly is a market structure where a single firm dominates the industry, with no close substitutes and high barriers to entry.
How do monopolies cause market failure?
Monopolies lead to consumers having no choice but to buy from that firm.
The firm therefore lacks the competitive pressures to keep costs and prices low and quality high.
Monopolies tend to be inefficient and exploit consumers with high prices
What is an example of a monopoly power exploiting consumers?
A local water supplier with no competition may increase prices for water as consumers have no alternative.
