Chapter 8 - The market mechanism, market failure & government intervention in markets Flashcards
What is the price mechanism
the manner in which the profits of goods or services affects the supply and demand of goods and services (principally by the price elasticity of demand.)
What are the 4 functions of prices
Signalling function
Incentive function
Rationing function
Allocative function
What is the signalling function
- Prices signal what is available, conveying information to producers and consumers alike
- If prices signal wrong or misleading information, then markets may perform inefficiently or break down completely
What is the incentive function
Prices create incentives for agents to behave in ways consistent with their self-interest. For example, the rising price of a good may:
• Result in a firm expanding production of that good in its pursuit of profit-maximisation
• Result in a consumer contracting demand as she tries to maximise her overall ‘utility’ with her limited income
What is the rationing function
Rising prices ration demand for a product. The higher the price, the fewer people can afford a good.
What is the allocative function
Changing relative prices will switch resources from markets of over supply to markets with excess demand. Think of the fishing villages in southern India we looked at.
Advantages of the price mechanism
Productively Efficient
Allocatively Efficient
Disadvantage of the price mechanism
Imperfectly Competitive Markets & Asymmetric Information
Value Neutral
What’s the 2 ways market fail
Inequitable
Inefficient
What is complete market failure
When the market does not exist (there is a missing market)
What is Partial market failure
The wrong quantity of a good is produced
What is market failure
where one or more of the functions of prices breaks down
What else can cause markets to fail
- Knowledge is not perfect - ignorance
- Goods are differentiated*
- Resource immobility
- Market power
- Services/goods would or could not be provided in sufficient quantity by the market
- Existence of external costs and benefits
- Inequality exists
What is social efficiency
where external costs and benefits are accounted for
What is allocative efficiency
where society produces goods and services at minimum cost that are wanted by consumers
What is technical efficiency
production of goods and services using the minimum amount of resources
What is productive efficiency
production of goods and services at lowest factor cost
What is imperfect knowledge
- Consumers do not have adequate technical knowledge
- Advertising can mislead or mis-inform
- Producers unaware of all opportunities
- Producers cannot accurately measure productivity
- Decisions often based on past experience rather than future knowledge
What is a private good
Consumption by one person results in the good not being available for consumption by anyone else.
What is a public good
A good where consumption by one person does not reduce the amount available for consumption by another person AND once provided all individuals benefit or suffer whether they wish to or not.
Examples of a pure public good
Defence
Police
Street light
What is a quasi public good
A good which may not perfectly possess the characteristics of being non excludable but which is non rival.
What is a free economy
where supply and demand regulate production and labor as opposed to government intervention.
Definition of non-excludable
once the goods are provided, it is not possible to exclude people from using them even if they haven’t paid.
Definition of non-rival
this means that consumption of the good by one person does not diminish the amount available for the next person.
What was the tragedy of the commons
Renewable resources are being depleted because of over consumption
What is an externality
third party effects arising from production and consumption of goods and services for which no appropriate compensation is paid
Can externalities cause market failure
Yes, if the price mechanism does not take into account the full social costs and benefits of production and consumption
What do externalities effect
they affect economic agents not directly involved in the production and/or consumption of a good or service
Example of negative externalities
Smokers ignore the impact of ‘passive smoking’ on non-smokers
Air pollution from road use
What are private costs
Are paid only by the producer or consumer concerned
They are internal costs of production or consumption
Formula for Social cost
Social cost = private cost + external cost
What do negative externalities do to social costs and benefits
Add social costs
Reduce social benefits
What externality does private cost > social cost have
Positive externalities
What externality does private cost < social cost have
Negative externalities
Formula for social benefit
Social benefit = Private benefit + external benefit
What is the PPF
a curve which shows the maximum potential level of one good given a level of output for all other goods in the economy.
What is the secondary sector
production of goods, mainly manufactured.
What is an index number
an indicator showing the relative value of one number to another from a base of 100. It is often used to present an average of a number of statistics.
What is is utility
the satisfaction derived from consuming a good
What can generate positive externalities
- Social returns from investment in education & training
- Positive benefits from health care and medical research
- Benefits from vaccination and immunization programmes
- Provision of flood protection systems & fire safety equipment
- Restored historic buildings and monuments
- External benefits from usage of public libraries and museums
What is a social benefit
the total benefit to society from a good ie the benefit to individuals and any beneficial unintended spillover effects on third parties.
How do you tell something has negative externalities
social cost of production > the private cost
What is a merit good
A good which is underprovided by the market mechanism
A good which some people think should be provided in greater quantities
What does governments do to merit goods
Subsidy them or provide it for free at the point of use and funded by the government sector
Examples of merit goods
Health services • Education • Work / business training programmes • Environmental improvement schemes • Public libraries and museums and other cultural facilities
What can the free-rider problem cause
under-investment in training- Firms are concerned that once trained, an employee will leave the firm before the firm has recouped its investment. Unless training pays off very quickly, firms are therefore reluctant to provide training to their workers
What can imperfect information cause (For workers)
employees (workers) being unable to judge the quality of their training or appreciate the benefits to themselves
What are possible government interventions to boost training
• Increased funding for education and training programmes within
the public sector (e.g. within the education and health sectors)
• State funded modern apprenticeships and expansion of vocational exams
• Tax credits for businesses that invest in training programmes
• Regulation
Do museums provide external costs or benefits (negative or positive externalities)
external benefits to society (positive externalities) which leads to an improvement in social welfare
What is a demerit good
A product, such as alcohol, which consumers may overvalue but which the government believes may be harmful for consumers.
Characteristics of demerit good
- A demerit good is ‘socially undesirable’ and ‘worse’ for a consumer than the consumer realises eg alcohol
- De-merit goods are thought to be ‘bad’ for you
- Consumption can lead to negative externalities (leading to less social welfare)
Examples of demerit good
Gambling
Smoking
Obesity
Drug addiction
How strategies can control consumption of demerit goods
Health awareness programmes
Taxation of demerit goods
Statutory regulation (banning/limiting some products by age)
Subsidising healthier substitutes
What is factor immobility
places barriers to the movement of factor inputs to their most productive use
Why do we need factor mobility
Evolving consumer tastes, new products, processes and labour saving technologies mean factors of production currently producing, say, analogue cameras need to switch to alternative uses, say, digital cameras.
Why is factor immobility bad
Immobile resources means the economic system cannot meet changing needs or adapt to changing process of production
The geographical immobility of labour
- Family and other social ties
- The costs involved in moving home
- Regional variations in house prices and shortages of rented property
- Differences in living costs between regions
- Language barriers
- Differences in tax, social security and pension systems between countries
- Legal limits on the scale of labour migration allowed into a particular country
What are 3 government policies to improve geographical mobility
- Improve the supply of housing and reduce the cost of rented properties
- Offer subsidies for people moving into areas where there are shortages of labour
- Harmonisation of welfare and tax systems to encourage inward migration of labour within the European economy
What is occupational immobility
Workers having barriers to change job/occupation
What can occupational immobility of labour cause
- structural unemployment
* a waste of scarce resources and a loss of efficiency
How can you improve occupational mobility
- (1) Training schemes for those workers experiencing structural unemployment
- (2) Increased investment in vocational education and lifetime learning opportunities
- (3) Encourage businesses to introduce more flexible working patterns
What is the competition policy
a mechanism of disciplined pluralism, which rewards success and penalizes failure. The purpose of competition policy is to protect that mechanism.
What is government regulation
rules set by government or their agencies that control the operations of firms. (Regulation is designed to correct for market failure)
What are the 3 areas of competition policy
- Monopolies
- Mergers
- Restrictive Practices
What is a monopoly
where one firm has at least 25% of a market
What are the 6 pillars of the UK competition policy
Prevention Regulation of monopolies Anti-cartel Deregulation Market contest-ability remove restrictive practices
What is privatisation
the transfer of assets from state ownership to the private sector
What’s deregulation
the removal of restrictions on the provision of a good/service
What’s are some arguments for privatisation
Promotes efficiency
Promotes competition
Raises revenue for government
Promotes popular capitalism
What are some arguments against privatisation
Decrease in efficiency
Short-term
Closure of loss making services (railway branches, village post offices)
Selling the family silver (better to retain these assets to generate revenue for government in the long run)
What is Public-private partnerships (PPP)
partnerships between the private and public sectors to provide public services such as healthcare, prisons, residential care homes and schools.
What is direct provision
Governments can supply public and merit goods directly to consumer free of charge as in the example of primary school education or visits to the GP
What is subsidised provisions
The government may pay for part of the good or service but expect consumers to pay the rest. Dental care and prescriptions are subsidised in this way in the U.K.
What is regulation (In terms of government regulation)
The government may leave provision to the private sector but make consumers purchase a merit good eg. Motor insurance
Ways of correcting market failures
- One extreme - Abolish the market
- Impose Regulations
- Taxes & Subsidies
- ‘Nudging’ e.g. Opt-out, usage data & painted urinals
What are 3 types of taxation
- Specific or flat rate – amount per unit
- Ad Valorem – percentage of the price
- Levied on the producer – indirect tax
Examples of taxation
VAT, excise duties, tariffs, levies, duties (e.g. stamp duty) National Insurance Contributions (NICs)
Effects of tax (not taxation)
- Increases price
* Reduces consumption/output
Effects of taxation
- Distortion of the market
- Influence on behaviour
- Extent of the effect dependent on the degree of elasticity (number of substitutes, addictiveness of the product, proportion of income devoted, time scale)
- Creation of underground markets – smuggling, booze cruises, etc.
- Increases business costs (competitiveness increase)
- Raises revenue to help pay for government services
Characteristics of subsidises
- Aim to change relative prices
- Given to the producer
- Used to help re-distribute income
- Used to help firms compete
Examples of subsidy
state benefits, free school meals, working tax credits, agriculture, transport, regional development, housing, employment, education
