Market Failure Flashcards
Market failure
When the free market mechanism fails to allocate resources efficiently (inefficient resource allocation)
Examples of market failure
- Overconsumption
- Underconsumtpion
- Underproduction
- Overproduction
Types/Causes of market failure
1) Externalities
2) Under-provision public goods
3) Information gaps
Externalities
Costs and Benefits that do not go through the price mechanism
Private costs
Any costs a firm pays in order to buy or produce goods and services i.e. cost of labour, material, machinery
External costs/Negative externalities
Costs to a third party arising from production and consumption of goods/services for which no appropriate compensation is paid
Social costs
Total cost of producing product/service to society
- Private costs + External costs
Private benefits
Benefits received by the consumer or the producer
External benefits/Positive externalities
Benefits to third parties which are not taken into account by the price mechanism
Social benefits
Total benefit of producing product/service to society
- Private benefits + External benefits
External costs/Negative externalities of production using marginal analysis
Where the marginal social cost of production is higher than the marginal private cost i.e. MSC > MPC
e.g. air, land, river and noise pollution resulting from factory emissions
Negative externalities private and social optimum
Private (assuming no negative externalities from consumption):
MPC = MPB
Social:
(MPC+Social costs):
MSC = MPB
Welfare loss
Where a firm’s decision to produce decreases the well-being of others, but the firm does not compensate those others
- Qsop up to Qp triangle
External benefits/Positive externalities of consumption using marginal analysis
Where the marginal social benefit of consumption is higher than the marginal private benefit
MSB > MPB
Positive externalities private and social optimum
Private:
(MPC = MSC) = MPB
Social:
(MPC = MSC) = MSB
Why would the government want to intervene regarding externalities
To ensure the market
considers the external costs and benefits
Public goods
Goods that are both non-rival and non-excludable
- they are an example of market failure as they are under-provided without government intervention
Non- rival and Non-excludable meanings
Non-rival: the consumption of one individual does not reduce the availability of goods to others
Non-excludable: the goods cannot be confined to those who have paid for it
Non-rejectable
The collective supply of a public good for all means that it cannot be rejected by people
The Free Rider Problem
When people take advantage of a benefit like public goods being provided to get them for free
Information failure
Refers to many increases surrounding the use of information in making economic decisions, and where this results in an inefficient allocation of resources
Information failure
Where use of information in making economic decisions results in an inefficient allocation of resources
Different forms of information failure
- not enough information
- too complicated
- asymmetric information
- misleading information
Symmetric and asymmetric information
Symmetric: where parties in a transaction know the same information
Asymmetric: where one party knows more than another in an economic transfer
Examples of asymmetric information
Pensions: people dont know how long they will live
Sun beds: understanding about skin cancer risk
Insurance: consumers understanding of risk
How to fix information failure
Advertising
Price comparison websites
Consumer watchdogs
Government regulations
