market failure(1.3)&Gov intervention(1.4) Flashcards
what is market failure?
market failure is when the market fails to allocate resources efficiently, causing a loss in social welfare.
what are the 3 types of market failure?
-externalities
-under provision of public goods
-information gaps
define externalities.
costs or benefits that are external to an exchange that are 3rd party effects ignored by the price mechanism OR spill over effect as a result of production or consumption of a good/service
what can external costs (negative externalities)occur from?
from production and consumption
e.g. chemical firm polluting into a river
e.g. smoker polluting air
what are private costs?
costs that are internal to the firm which it pays for directly e.g. wages, rent, cost of raw materials
what are the characteristics of private goods?
they are excludable and rivalrous
what are the characteristics of a public good?
they are non-excludable and non-rivalrous e.g. street lamps, national defence
what is the problem with public goods?
there is a free rider problem where people can benefit from consuming a g/s they have not paid for.
consumer no incentive to pay for it and neither do producers
what is the difference between asymmetrical and symmetrical information in information gaps?
symmetrical information-buyer and seller have access to the same information
asymmetrical information-buyer or seller has more information than the other
why do information gaps exist?
Information gaps exist when either the buyer or seller does not have access to the information needed for them to make a fully-informed decision.
what are some examples of information gaps?
risk from tanning salons
addiction to drugs
what are social costs?
social costs = private costs + external costs
( the total benefit to society from producing or consuming a good/service.)
what is government intervention?
gov intervening if they want to increase total welfare. They do this if the costs of intervention are less than the benefits gained by intervention
define demerit good.
a good/service which consumption is unhealthy or socially undesirable.
what are the 2 types of indirect taxes in gov intervention?
-specific(fixed amount of tax)
-Ad valorem(based on value of good/s)
how do subsidies help firms?
-switch to sustainable/renewable resources
-supply more output
-reduce prices
-encourage consumers to buy more merit goods
why are maximum prices set by the government?
to prevent the market price form rising to a certain level. e.g. house prices and energy price cap(necessities)
what are the pros of maximum prices?
-surrogate for competition
-holds prices down(consumer welfare gain)
-incentives for businesses to cut costs to maintain profits
what are the cons of maximum prices?
-reduces profits (less money for capital investment)
-firms might raise prices in other ways
-unofficial price can create a black market
why are minimum prices set by the government?
so that consumption of the good will fall, resulting in a welfare gain to society.
what are the 8 ways gov can intervene to correct market failure?
subsidies
indirect tax
min and max prices
trade pollution permits
state provision of public goods
provision of information
regulation
prohibition
pros and cons of minimum prices?
pros:
-potentially large revenues for retailers
cons:
-risk of black market
-not allocatively efficient income
-no tax revenue for gov
-if demand is price inelastic then it may have little effect
what is a tradable pollution permit?
a permit from the gov to firms allowing them to pollute up to certain limit. These are tradable so clean firms can sell their permits to other firms who want to go over their limit.
Makes firms accountable for their actions
pros of tradable pollution permit.
-overall level of pollution can be controlled by gov
-incentive for polluting firms to reduce their emissions
cons of tradable pollution permit.
-enforcement is difficult
-increased costs for firms
-difficult for gov to decide how many permits to produce
-can lead to gov failure
what is the UK pollution permit trading system called?
UK ETS
what is the example of a state provided public good?
HS2
a high speed rail link between london, birms, manny, leeds, sheffield expected to finish in 2026
expected to cost over £200 billion
what does provision of information do?
try to fix asymmetric info e.g. gov forcing cigarette suppliers to put info on boxes
pros and cons of provision of information.
pros:
-positive benefit of merit goods will increase and consumption closer to social optimum
cons:
-can be expensive
-difficult to assess success rate
what is regulation and prohibition
regulating-imposing laws to restrict behaviour
prohibition-complete ban on activity
what is gov failure?
when gov policies have an unintended effect that does not successfully eliminate market failure.
what are the causes of gov failure?
-distortion of price signals
-unintended consequences
-excessive administrative costs
-information gaps
explain distortion of price signals(gov failure)
when relying on supply and demand to make equilibrium and gov intervene via tax/subsidies etc
—>inefficient allocation of resources because market mechanism isn’t able to act freely
explain unintended consequences(gov failure)
Gov policies may cause consumers/producers to react in unexpected ways
e.g. ban of cigarettes leads to huge increase in e-cigarettes
explain excessive administrative costs(gov failure)
when the social benefits of a policy might not be worth the financial cost of administering the policy and might cost more than anticipated e.g. HS2 project
explain information gaps(gov failure)
some policies may be decided without perfect information. Might require cost-benefit analysis which is expensive and time consuming
HOWEVER it is impractical for gov to gain complete perfect info so they make assumptions
