Chapter 3 Flashcards
Define Market Failure
Absence of government intervention and presence of externalities.
Why does the government intervene?
- To fix issue of overconsumption and underconsumption
- To allow provision of public goods
- To fix prices
How can government intervention be harmful?
Deadweight loss.
It prevents the price mechanism from operating effectively, it does not allow price to act as a signal to reflect changes in demand and supply.
Also affect, rationing and incentives.
Characteristics of market failure
- Absence of merit and public goods
- Presence of Demerit goods
- Presence of monopoly
- Information Failure
- Resource depletion
- Social costs> social benefits
Why is there absence of merit and public goods in the market?
Merit goods are absent in a free-market as they’re non-profitable; they are not highly demanded, so the firms will make low profits.
Public goods are not provided by the private sector due to the free-rider problem, people gain all the benefits of a public good without paying for it in return, and they lack any incentive to pay for it, so the private sector won’t gain any profits.
Why are merit goods underconsumed?
Due to information failure:
- People underestimate the private benefit and overlook social benefit (People aren’t aware of education’s long term positive impact)
- May be overpriced
How does the government intervene to allow provision of merit goods and public goods?
Grants subsidies to firms to lower their costs of production and motivate them to supply more to gain higher profits.
The government provides the public goods itself.
Advantages of subsidies
- Lowers prices of necessities
- Merit goods are cheaper, so solves issue of underconsumption
- Lower poverty
- Encourages competition
Disadvantages of subsidies
- Opportunity cost for the govt.
- Budget deficit
- Blanket problem
- Inefficiency
Why are demerit goods overproduced?
Demerit goods are inelastic, no matter how expensive they are, people are still willing to purchase them. This allows the firm to gain higher profits.
Why are demerit goods overconsumed?
Due to information failure:
- People only focus on the private benefit on the short-term and overlook any long-term harm on both self and economy
- Addictive
- Underpriced
- Misleading ads (Junk food ads focus on taste not obesity)
How does the government intervene to prevent presence of demerit goods?
Imposes indirect taxes to increase costs of production and demotivate suppliers to supply, so quantity supplied drops and the product becomes scarce and expensive; this might lower quantity demanded.
Advantages of indirect taxes
Increases cost of production of firms that supply demerit goods, so less overproduction.
Tax revenue.
Encourages economic efficiency
Disadvantages of indirect taxes
Regressive taxation, affects poor people.
Govt intervt. leads to DWL
Govt intervt. prevents PM from working efficiently and effectively.
Might be useless if imposed on demerit goods as they’re inelastic demand
What causes monopoly?
A firm taking over 50% or more of the market share, and sets extremely high prices with low quality since there are no other substitutes. They are very inefficient as they can pass on cost of wastes onto consumer as inelastic.
How does the government prevent monopolies from arising?
Government imposes maximum price, which is a price-ceiling, firms are prevented from setting a price that is higher. This will eventually lower market price and make things more affordable.
Government can also grant subsidies to encourage more competition.
Advantages of maximum price
Prevents monopolies from arising and exploiting consumer.
Lowers prices of necessities and makes it more affordable and more consumed.
Disadvantages of maximum price
This will demotivate suppliers from supplying the good as they’ll earn lower profits.
There will be excessive demand despite there being a low supply.
This will lead to a shortage and an informal economy, where black market sells the good at an even higher price.
What causes resource depletion?
Resources are underpriced, so people are overconsuming it carelessly.
How can the government prevent resource depletion?
By imposing minimum price, a price flooring above market price to raise the prices and make products less affordable.
Advantages of minimum price
Raises prices of demerit goods which can prevent issue of overconsumption
Prevents resource depletion
Motivates suppliers to supply more, leading to higher output
Disadvantages of minimum price
There is increased supply, but limited demand. This will lead to a surplus.
Ineffective when setting it on demerit goods as inelastic demand.
Define direct provision
Direct provision is when the government itself directly provides the good, like public schools, hospitals and so on.
This is due to the free-rider theory.
Define bufferstock scheme
Bufferstock scheme is when the government intervenes to help stabilize price and availability of an item by buying the stock during excess supply and selling it during shortages.
