Distribution Of Income And Wealth, Poverty And Inequality Part 1 Flashcards
What do the price mechanisms do?
Determine the market price
Allocate resources in a free market economy
What are the 3 main function to allocate resources used by the price mechanism?
Rationing
Incentive
Signalling
Explain the function of the price mechanism: rationing?
An increase in price will discourage demand and consequently rations resources (because demand decreased)
Explain the function of the price mechanism: incentive?
The price will encourage a change in behaviour in. Producers and consumers. Eg profit acts as an incentive and high prices act as an disincentive
Explain the function of the price mechanism: signalling
It shows where the resources need to be allocated. A high price tells firms that there is profit to be made
How is the basic economic problem solved?
The price mechanisms
What are the advantages of price mechanisms?
It is unbiased
It can be useful to consumers and producers
It gives consumers sovereignty in the market so they will have a “spending vote”
This is generally works well
What are the disadvantages of the price mechanisms?
It doesn’t consider what the distribution of income is the free market and the price mechanism ignores equality
In the free market merit goods and public goods are underproduced, which require government intervention
When does market failure occur?
Whenever a market leads to the misallocation of resources
What is a misallocation of resources?
This is when resources are not allocated to the best interests of society. There could be more output in the form of goods or services if the resources were used in a different way
Why should we care about market failure?
Economic and social welfare is not maximised
What are the different types of market failure?
Externalities
The under provision of public goods
Information gaps
Monopolies
Inequality in the distribution of income and wealth
Explain the type of market failure externality?
If there are negative externalities then social welfare is not maximised as there will therefore be marginal social costs as well as marginal private cost
Define externality?
The cost or benefit that a third party received from an economic transaction
Explain the market failure the under provision of public goods
Public goods are non excludable and non rival, and they are underproduced in a free market because of the free rider problem
Explain the market failure: information gaps?
It is assumed that the consumers and producers have perfect information when making decisions. This is not true. This imperfect information leads to a misallocation of resources
Explain the market failure: monopolies
In this marker structure consumers are often overcharged. This leads to underconsumption of the good or service. This leads to a misallocation of the resources as consumers’ needs and wants aren’t fully met
Explain the market failure: Inequalities in the distribution of income and wealth
Wealth is not distributed equitably. This can lead to negative externalities such as social unrest
Define income?
A flow of money
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Define wealth?
The value of assets some on owns
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What are the 2 variations of market failure?
Complete and partial market failure
When does complete market failure occur?
When there is a missing market (the good is not being sold)
When does partial market failure occur?
When the market produces the good but at the wrong quantity or the wrong price or both
This shows resource misallocation
Where are public goods missing?
Why is this bad?
The free market
They provide positive externalities
What are the characteristics of public goods?
They are non excludable and non rival and they are non reject-able
What does non excludable mean?
You can’t prevent someone from using it
What does non rival mean?
The benefit of someone else from the good doesn’t decrease when someone else is using it
Why are public goods under provided in the private sector?
They are non excludable meaning that you have the free rider problem - people won’t buy the good if they think someone else will buy it
As a result people won’t buy public goods and as a result there is little profit to be made so private firms won’t sell them
It is also difficult to give them a value because it is difficult to value what the consumer gets from the good.
Generally consumers also undervalue the benefits of public goods
How are public goods provided?
By the government who use tax revenue to provide them. However the quantity provided will likely be less than the socially optimum quantity
The government needs to estimate the the social benefit of the good when deciding what output to produce
Describe a private good?
These goods are rival, excludable and rejectable
