Market Failure Flashcards
Types of market failure?
Lack of property rights Lack of competition Missing markets Unstable markets Incomplete markets Information failure
Information failure
Not all of the principles in an economic exchange have perfect knowledge about the details of that exchange
What are the two types of information failure?
Imperfect knowledge
Asymmetric information- information is not equally shared between two parties
Incomplete markets
Private sector does not/cannot completely meet the requirements of the market (under-provides) and some intervention from the state is needed
Unstable markets
Primary product markets can become unstable and require intervention to help them stabilise
Missing market
Services which are not viable for private sector to provide
Lack of competition
A market which is not competitive called a monopoly
Lack of property rights
Markets are less effective when property rights do not exist
Name some ways the government can intervene to correct or reduce market failure?
Taxation and subsidies Government expenditure Buffer stock systems Price controls Legislation and regulation
Free rider problem?
Someone who receives the benefit but allows others to pay for it
On a graph, where would the welfare loss arrow be for a positive externality of production?
Below equilibrium, pointing right
When trying to find the welfare loss, what should you do from equilibrium?
Compare social benefits to social costs
Where would the welfare arrow be if it is a positive externality of consumption?
Above equilibrium, pointing right
Social costs
Are the total cost to society of a given economic activity
Social costs= private cost + external costs
Social benefits
Are the total gain to society from a given economic activity
(Social benefits= private benefits + external benefits)
In this market failure topic what does the demand curve become?
D=MPB
In this market failure topic what does the supply curve become?
S=MPC
Negative externality
Are the costs incurred by third parties (external costs) as a result of an economic transaction
On a graph, which way would the welfare loss arrow point for a negative externality?
Left
On a graph is it’s a negative externality of consumption, where would the welfare loss arrow be?
Below equilibrium, pointing left
On a graph, if it is a negative externality of production, where would the welfare loss arrow be?
Above equilibrium, pointing left
On a graph which way would the welfare loss arrow point for a positive externality?
Right
External benefits
Is the benefit that a consumer or producers economic activity gives others
Allocative efficiency
Is where the scarce resource are used to produce the goods and services that consumers actually want
Externality
Occurs when a third-party is affected by the consumption and/or production of others
If it is a positive externality of production, describe the graph?
MSC shifted right/down, price would have decreased but QD increased
Welfare loss pointing right, below equilibrium
If it is a positive externality of consumption describe the graph?
MSB has shifted right/up price would have increased as well as quantity
Welfare loss pointing right, above equilibrium
If it is a negative externality of consumption, describe the graph?
MSB/MPB has shifted left/down price would have decreased as well as quantity
Welfare loss pointing left below equilibrium
If it is a negative externality of production describe the graph?
MSC has shifted left/up above MPC, price would have increased, QD decreased
Welfare loss pointing left, above equilibrium
When does market failure occur?
When the free market fails to allocate resources efficiently
Merit goods
Are those goods and services that the government feels that consumers will under-consume and which ought to be subsidised or provided free at point of use
Examples of demerit goods
Alcohol
Tobacco
Gambling
Junk foods
Demerit goods
A good that brings less benefit to consumers than they expect, such that too much would be consumed by individuals in a free market
Name some examples of merit goods
Healthcare
Public libraries
Museums
What are merit goods essentially?
Positive externalities of consumption
Difference between demerit goods and negative externalities
Demerit goods focus mainly on the harm to actual consumer of the good. Negative externalities focus on the harm inflicted on third parties
Moral hazard
Occurs when entity has an incentive to increase its exposure to risk because it does not bear the full costs of that risk
E.g. phone cover if phone becomes lost
What would the impact be if buffer stocks are used when a commodity is under pressure in rising in price?
Government release supply causing S to shift right
What would the impact be if buffer stocks are used when a commodity is under pressure in falling in price?
Government buy up the excess stock causing D to shift right
How will an indirect tax affect the S/D diagram?
Shift supply to the left
Price increase
Quantity decrease
What are some of the problems which could be said that won’t make the indirect tax effective
1) price inelastic demand-due to the addiction very few substitutes the therefore won’t effect the quantity
2) setting tax at a right level (govt doesn’t have perfect knowledge)
3) black markets- criminal activity if tax too much!
What could be said about the revenue generated by the government through taxation?
Used to fix market failure e.g. form of subsidy
Useful in solving market failure, to efficiently allocate resources
What would the impacts of an indirect tax have
Increase costs of production
Internalises externality (polluter pays)
Solves over consumption/production
Promotes allocative efficiency while generating govt revenue
Some impacts of a subsidy
Lower costs of production Decrease price and increase quantity Solves under consumption/production Allocative efficiency Welfare gain
For a subsidy to work most efficiently what is needed
Needs to be price elastic demand, greater degree of quantity in the market, solve market failure
State some points for government failure which could be caused by a subsidy?
Setting the subsidy at the right level (under-subsidise over-subsidise)
How will the firms use the subsidy, may use to increase wages and not use it for the correct intention the government had had
Creates dependency issues in the long run, if taken away
What would the impact be on a S/D diagram when firms are given a subsidy?
Supply shifts right
Price decreased
Quantity increased
Common access resources
Natural resources over which not private ownership has been established
‘Tragedy of the Commons’
Caused by the lack of private ownership, led to self-interest and resource depletion
Buffer stock
Occurs when the government store agricultural products and commodities in order to maintain stable prices in a market
Private benefits
Are the gains to individual of firms from consuming or producing an item
Private costs
Are the costs to individuals or firms of consuming or producing an item
If demand/supply is inelastic the incidence of the tax will be…
…greater for the consumer/producer
If the consumer has more information that the producer then…
…the producer may under-estimate the private cost of producing the good or service
Supply too much
What is Price control?
Is when the government set maximum or minimum prices for a good or service
Property right
Confer legal control or ownership of a good
If the producer has more knowledge than the consumer then…
…the consumer may over-estimate the private benefit they receive from the product
Demand too much
Public good
CANNOT normally be provided by the private sector. They are commodities or services provided with out profit to all moments of society
Quasi-public goods
Have characteristics of both private and public goods
Features of public goods
1) non-rivalry- consumption of the good by one person does not reduce the amount available for others
2) non-excludability-once provided, no person can be excluded
Government failure
They can tax, regulate and control but the outcome may be a deepening of the market failure or even worse a new failure
Examples of public goods
Lighthouses
Street lighting
Defence
Clean air
Solutions to the problems of demerit goods
Tax, regulating or prohibiting manufacture, sale and use
External costs
Are the costs to other people of organisations of decisions taken by a person or business
Why are demerit goods examples of market failure?
Government judges that certain goods will be over-consumed, left to the market mechanism
All demerit goods are capable of creating negative externalities, associated with consumption
Why are merit goods examples of market failure?
Merit goods are prone to information failure
Uneven access to merit goods may create inequality
Examples of Quasi public goods?
Beaches. Consumers who pay for a stay at a hotel which has a private beach. It can be excludable
They can also be rivalrous during congested times (summer) an individual reducing space for other potential individuals
Advantages of Nationalisation
- State provision can reduce inequality by redistributing money
- Without state provision, some services might not exist as they aren’t profitable e.g. some train routes
Disadvantages of Nationalisation?
- Without a drive for profit, there is less incentive to make a service as efficient as possible
- With asymmetric information, there is a risk of government failure
Advantages of Privatisation?
- The incentive for profit means that resources will be allocated more efficiently
- When the government sell off their enterprise, they will gain revenue that can be put to alternative use
Disadvantages of Privatisation?
- There is a moral argument against providing some services profitably
- The drive for efficiency means that an element of humanity might be lost. Efficiency may come in the way of delivering a fair service
What would the impact be if a minimum price was imposed on demerit goods (NEC)?
- Demand will contract
- Q will fall as consumption is discouraged
- P will increase
- Q will fall to the socially optimum level
- Externality will be internalised, will solve the over-consumption and over-production of demerit goods
- Get to allocative efficiency, welfare maximised
What are the possible issues with imposing a minimum price of demerit goods such as alcohol?
- Regressive tax
- Black market
- Price Inelastic Demand
- Whether the minimum price is set at the right level
The main reason for the imposition of a maximum price?
-Encourage more consumption and equity
What are the many indirect issues with the imposition of a maximum price?
- Government create this excess demand
- Supply is contracted but Demand is extended
- Black market because of the shortage cause, which could see consumers be exploited
