Kennahs economic 1.3 market failure

Question 1

What is market failure

Answer 1

Is where too little or too much of a good is being produced and/ or consumed compared with the socially optimal level of output.

Or when the market(price mechanism) fails to allocate resources efficiently causing a loss in social welfare

Question 2

What are the 4 types of market failure

Answer 2

*externalities
*under provision of public goods
* information gaps
*monopoly

Question 3

What are externalities

Answer 3

The cost or benefit a third party receives from an economic transition outside of the market mechanism.
It is the spillover effect of the production or consumption of a good or service.

This leads to the over or under provision of goods meaning resources aren’t allocated efficiently.

E.g cars and cigarettes have negative externalities while education and healthcare have positive externalities.

Question 4

What are under provision of public goods

Answer 4

Public goods are non-rivalry and non-excludable meaning they are under provided by the private sector due to the free-rider problem. The market is unable to ensure enough of these goods are provided.
E.g streetlights.

Question 5

Information gaps

Answer 5

Consumers are assumed to have perfect information allowing them to make rational decisions. Firms are assumed to have perfect information on their cost and revenue and governments are assumed to know the full cost and benefit of each decision.
However this is not the case therefor economic agents do not always make rational decisions and so resources are not allocated to Maximise welfare.

E.g consumers do not know the quality of second hand products like cars

Question 6

What are private costs/benefits

Answer 6

The costs/benefits to the individual participating in the economic activity

Question 7

What are social costs/benefits

Answer 7

The costs/benefits of the activity to society as a whole

Question 8

What are external costs/benefits

Answer 8

The costs/benefits to a third party not involved in the economic activity.

Difference between private costs and social costs

Question 9

What is a merit good

Answer 9

A good with external benefits, where the benefit to society is greater than the benefit to the individual

Tend to be underprovided in the free market

Question 10

What is a demerit good

Answer 10

A good with external costs, where the cost to society is greater than the cost to the individual. They tend to be over provided in the free market