Chapter 3

Question 1

Market Failure

Answer 1

Market Failure occurs when the free operation of market forces leads to an Inefficient allocation of resources, which doesn’t maximise the satisfaction of society’s needs and wants.

Overallocation of resources to the production of some goods, and under-allocation of resources to the production of others, such that society’s well-being is not maximised.

Question 2

Public Goods

Answer 2

Public goods are non-rivalrous, non-depletable and non-excludable, meaning anyone can consume these goods or services even without paying and without reducing the amount available.

Examples: Lighthouses, street lights, police forces, public sanitation, free TV broadcasts, National defense

Question 3

Why are Public Goods a Market Failure?

Answer 3

Public goods aren’t profitable due to them being non-excludable (the free-rider problem), and since Private Firms are profit motivated, this leads to an under-allocation of resources to public goods. This would mean that social welfare is not maximised. This would be an inefficient allocation of resources, thus a market failure.

Question 4

Private Goods

Answer 4

Owned by private firms, these goods are Rivalrous, Excludable, and Depletable. This means that consumers have to pay to consume the product, and consumption by one person reduces the amount available.

Examples: Apples, Chips, Cars, Houses, iPhones

Question 5

Common Access Resources

Answer 5

Common Access Resources are Non-Excludable but Rivalrous, therefore consumers may use them without paying but the consumption by one person leads to a reduction in the overall amount available.

Examples: Fish in open water, Hunting grounds, Forests, roads (maybe)

Question 6

Why are Common Access Resources a Market Failure?

Answer 6

Since private firms are self-interested and profit-driven, they’ll use as much of common access resources as possible. This would be an over-consumption of a good or service. (aka. Over-allocation of resources to production)

Since CARs are depletable, this would decrease the amount available in the future, therefore this would be a decrease in Inter-temporal efficiency and future social welfare won’t be satisfied: Market Failure.

(Unsustainable development)

Question 7

Types of Government Intervention
(Public goods / C.A.R / Externalities / Asymmetric Information)

Answer 7

1. Fix Market Failure from Public Goods: Pay for the Public Goods using their Tax revenue.
2. FIx Market Failure from C.A.R: Use legislative powers to reduce consumption and promote sustainable development. Like, banning the use of C.A.Rs or restricting it.
3. Address Negative Externalities: Create an internal financial cost for the activity which creates the externality: Consumption Tax or Indirect Taxes on producers (excise). For positive Externalities: Create an internal financial benefit: subsidies
4. Asymmetric Information: Australian Consumer Law makes it illegal for firms to mislead or deceive consumers or other businesses. Governments can also use awareness programs like ads to inform consumers of common problems.

Question 8

Externalities

Answer 8

A cost or benefit associated with the Production or Consumption of a product, which impacts a 3rd Party (Not the buyer or seller).

Examples:
Cost (negative): Pollution from Factories, Traffic congestion, Cigarettes
Benefits (Positive): Education, Vaccination

Question 9

Why are Externalities considered a Market Failure?

Answer 9

There will be an Over-allocation of resources to products that have negative externalities since these costs are not taken into account by the buyer or producer.

There will be an under-allocation of resources to products that have positive externalities since these benefits will not be taken into account.

Question 10

Asymmetric Information

Answer 10

This means that the buyer or seller has more information about the good or service being bought or sold than the other.

Question 11

Why is Asymmetric Information a Market Failure?

Answer 11

Asymmetric information can alter the behaviour of the buyer or seller and lead to high or below “fair value” prices.

This can cause each party to make decisions based on inaccurate/unreliable or incomplete information, which can lead to the need for increased spending later, which would be an inefficient allocation of resources. This would be considered a market failure.