market failure(1.3)&Gov intervention(1.4)

Question 1

what is market failure?

Answer 1

market failure is when the market fails to allocate resources efficiently, causing a loss in social welfare.

Question 2

what are the 3 types of market failure?

Answer 2

-externalities
-under provision of public goods
-information gaps

Question 3

define externalities.

Answer 3

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

Question 4

what can external costs (negative externalities)occur from?

Answer 4

from production and consumption
e.g. chemical firm polluting into a river
e.g. smoker polluting air

Question 5

what are private costs?

Answer 5

costs that are internal to the firm which it pays for directly e.g. wages, rent, cost of raw materials

Question 6

what are the characteristics of private goods?

Answer 6

they are excludable and rivalrous

Question 7

what are the characteristics of a public good?

Answer 7

they are non-excludable and non-rivalrous e.g. street lamps, national defence

Question 8

what is the problem with public goods?

Answer 8

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

Question 9

what is the difference between asymmetrical and symmetrical information in information gaps?

Answer 9

symmetrical information-buyer and seller have access to the same information
asymmetrical information-buyer or seller has more information than the other

Question 10

why do information gaps exist?

Answer 10

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.

Question 11

what are some examples of information gaps?

Answer 11

risk from tanning salons
addiction to drugs

Question 12

what are social costs?

Answer 12

social costs = private costs + external costs
( the total benefit to society from producing or consuming a good/service.)

Question 13

what is government intervention?

Answer 13

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

Question 14

define demerit good.

Answer 14

a good/service which consumption is unhealthy or socially undesirable.

Question 15

what are the 2 types of indirect taxes in gov intervention?

Answer 15

-specific(fixed amount of tax)
-Ad valorem(based on value of good/s)

Question 16

how do subsidies help firms?

Answer 16

-switch to sustainable/renewable resources
-supply more output
-reduce prices
-encourage consumers to buy more merit goods

Question 17

why are maximum prices set by the government?

Answer 17

to prevent the market price form rising to a certain level. e.g. house prices and energy price cap(necessities)

Question 18

what are the pros of maximum prices?

Answer 18

-surrogate for competition
-holds prices down(consumer welfare gain)
-incentives for businesses to cut costs to maintain profits

Question 19

what are the cons of maximum prices?

Answer 19

-reduces profits (less money for capital investment)
-firms might raise prices in other ways
-unofficial price can create a black market

Question 20

why are minimum prices set by the government?

Answer 20

so that consumption of the good will fall, resulting in a welfare gain to society.

Question 21

what are the 8 ways gov can intervene to correct market failure?

Answer 21

subsidies
indirect tax
min and max prices
trade pollution permits
state provision of public goods
provision of information
regulation
prohibition

Question 22

pros and cons of minimum prices?

Answer 22

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

Question 23

what is a tradable pollution permit?

Answer 23

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

Question 24

pros of tradable pollution permit.

Answer 24

-overall level of pollution can be controlled by gov
-incentive for polluting firms to reduce their emissions

Question 25

cons of tradable pollution permit.

Answer 25

-enforcement is difficult
-increased costs for firms
-difficult for gov to decide how many permits to produce
-can lead to gov failure

Question 26

what is the UK pollution permit trading system called?

Answer 26

UK ETS

Question 27

what is the example of a state provided public good?

Answer 27

HS2
a high speed rail link between london, birms, manny, leeds, sheffield expected to finish in 2026
expected to cost over £200 billion

Question 28

what does provision of information do?

Answer 28

try to fix asymmetric info e.g. gov forcing cigarette suppliers to put info on boxes

Question 29

pros and cons of provision of information.

Answer 29

pros:
-positive benefit of merit goods will increase and consumption closer to social optimum
cons:
-can be expensive
-difficult to assess success rate

Question 30

what is regulation and prohibition

Answer 30

regulating-imposing laws to restrict behaviour
prohibition-complete ban on activity

Question 31

what is gov failure?

Answer 31

when gov policies have an unintended effect that does not successfully eliminate market failure.

Question 32

what are the causes of gov failure?

Answer 32

-distortion of price signals
-unintended consequences
-excessive administrative costs
-information gaps

Question 33

explain distortion of price signals(gov failure)

Answer 33

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

Question 34

explain unintended consequences(gov failure)

Answer 34

Gov policies may cause consumers/producers to react in unexpected ways
e.g. ban of cigarettes leads to huge increase in e-cigarettes

Question 35

explain excessive administrative costs(gov failure)

Answer 35

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

Question 36

explain information gaps(gov failure)

Answer 36

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