LS17/18/19 - Market Failure

Question 1

What is market failure?

Answer 1

Too much or too little of a good is produced or consumed, compared to the socially optimum level of output, and when the price mechanism leads to inefficient allocation of resources.

Question 2

Types of market failure

Answer 2

Externalities, Public Goods, and Information Gap

Question 3

Externalities

Answer 3

External cost/benefit - A cost/benefit to a third party that is not involved in the making, buying/selling and consumption of a good or service. Ex: people are affected by second-hand smoking, even though they aren’t involved in the transaction.
External cost - negative externality - overproduction/overconsumption - too many resources spent producing good
External benefit - positive externality - underproduction/underconsumption - too few resources spent on producing good

Question 4

Social Benefits and Social Costs
Social Optimal Level of Output

Answer 4

Social Benefits = Private Benefits + External Benefits
Social Costs = Private Costs + External Costs
SOLO - when all external costs and benefits are taken into account

Question 5

Public Good

Answer 5

Non-rivalrous and non-excludable good - listening to a programme on the radio is non-rivalrous, as anyone can use it, one person cannot stop another. But the radio itself is a rivalrous good - only people that can afford it can purchase it.

Question 6

Free rider problem

Answer 6

Market failure occurs with the free rider problem as everyone benefits from it - no revenue is generated.
Even though they are not paying for this good, free riders continue to use it.
Good becomes under provided or not provided at all.

Question 7

Information Gap

Answer 7

When either the buyer or seller doesn’t have access to the information they need to make a fully informed decision.

Question 8

Types of Information Gaps

Answer 8

Perfect information - when a buyer and seller have complete understanding of the quality and nature of a g/s
Symmetric information - when buyers and sellers have equal amount of knowledge of a g/s
Imperfect information - when a buyer/seller lacks a complete understanding of a g/s
Asymmetric information - when a buyer or seller has more information of a g/s than the other party