Market Failure Flashcards
what is market failure?
Market failure occurs when freely-functioning markets,
operating without government intervention, fail to deliver an efficient or optimal allocation of
resources. Therefore - economic and social
welfare may not be maximised. This leads to a loss of economic efficiency
what is complete market failure?
when there is no market whatsoever, missing markets, goods/services not supplied to market as firms will not receive revenue for supplying the product
what is partial market failure?
markets exist but there is a misallocation of resources, goods/services supplied in wrong amounts e.g. merit and demerit goods
what are the typed of market failure?
externalities
under-provision of public goods
information gaps
externalities?
An externality is the cost or benefit a third party receives from an economic transaction outside of the market mechanism. In other words, it is the spillover effect of the production or consumption of a good or service. They are detrimental 3rd party effects
under provision of public goods?
Public goods are non-excludable and non-rival, and they are underprovided in a free market because of the free-rider problem.
information gaps?
It is assumed that consumers and producers have perfect information when making economic decisions. However, this is rarely the case, and this imperfect information leads to a misallocation of resources.
private costs?
Private costs are the costs to economic agents involved directly in an economic transaction. Producers are concerned with private costs of production. For example, the rent, the cost of machinery and labour, insurance, transport and paying for raw materials are private costs. This determines how much the producer will supply. It could refer to the market price which the consumer pays for the good.
social costs?
This is calculated by private costs plus external costs.
It is the cost to society as a whole.
private benefits?
Consumers are concerned with the private benefit derived from the consumption of a good. The price the consumer is prepared to pay determines this. Private benefits could also be a firm’s revenue from selling a good.
social benefits?
Social benefits are private benefits plus external benefits. On a diagram, external benefits are the difference between private and social benefits. Similarly to external costs, external benefits increase disproportionately as output increases.
social optimum position?
This is where MSC = MSB and it is the point of maximum welfare. The social costs made from producing the last unit of output is equal to the social benefit derived from consuming the unit of output.
private cost/benefit?
are the costs/benefits to the individual participating in the economic activity. The demand curve represents private benefits and the supply curve represents private costs.
social costs/benefits?
are the costs/benefits of the activity to society as a whole.
external cost/benefits?
are the costs/benefits to a third party not involved in the economic activity. They are the difference between private costs/benefits and social costs/benefits.
What are merit goods?
Goods for which the social benefits of consumption exceeds the private benefits and are under produced and under consumed if left to the free market. They produce positive externalities.
What are demerit goods?
A good with external costs, where cost to society is greater than cost to the individual. They tend to be over provided by free market and over consumed.
What are marginal costs/benefits?
It is the extra cost/benefit of producing/consuming one extra unit of the good.
E.g. the marginal private benefit (MPB) is the extra satisfaction gained by the individual from consuming one more of a good and the MSB is the extra gain to society from consumption of one more good.
Difficulty in measuring externalities
It is difficult to measure the size of externalities as it tends to be placed on value judgements, since it is difficult to monetise external costs. Many externalities are involved with information gaps as people are unaware of the full implications of their decisions
What can gov do to intervene with externalities?
Indirect taxes and subsidies Tradable pollution permits Provision of the good Provision of information Regulation
How do gov use taxes and subsidies to limit externalities?
Taxes can be put on goods with negative externalities and subsidies on goods with positive externalities. These help to internalise the externalities, moving production closer to the social optimum position.
How do gov use tradable pollution permits to limit externalities?
These allow firms to produce up to a certain amount of pollution, and can be traded amongst firms so give them choice whilst reducing level of pollution.
How does gov use provision of the good to limit externalities?
Since some externalities are associated with information gaps, gov can provide information to help people make informed decisions and acknowledge external costs.
