Market Failure Flashcards
The Four Price Mechanisms
Signalling - prices adujust to signal whether there are scarce of surplus resources
Allocation - How are scarce resources best allocated.
Rationing - Ration supply when demand outstrips supply
Incentives - If demand is increasing, there is a greater incentive for producers to increase supply.
Advantages of the Price Mechanism (5)
Efficiency: Price mechanisms allocate resources efficiently by directing goods and services to where they are most in demand. Prices act as signals to producers and consumers about where to allocate resources and how much to produce or consume.
Flexibility: Price mechanisms are flexible and respond quickly to changes in demand and supply. Prices can be adjusted easily to reflect changes in the market conditions, which helps in maintaining equilibrium in the market.
Incentives: Price mechanisms provide incentives to producers to produce more of the goods and services that are in demand, and to consumers to consume less of the goods and services that are scarce or expensive. This ensures that resources are allocated efficiently and the economy operates at its maximum potential.
Consumer sovereignty: Price mechanisms give consumers the power to determine what is produced and how much is produced. They are able to express their preferences through their willingness to pay, which helps producers to produce the goods and services that consumers want.
Innovation: Price mechanisms encourage innovation as producers are motivated to find new and more efficient ways of producing goods and services to reduce costs and increase profits.
Disadvantages of Price Mechanism (5)
Inequity: Price mechanisms can lead to inequity as prices can be too high for some people to afford essential goods and services. This can lead to a situation where some people are unable to access the basic necessities of life.
Externalities: Price mechanisms do not account for externalities such as pollution and other negative effects of production and consumption. This can lead to a situation where goods and services are produced and consumed even if they have negative effects on the environment or society.
Monopoly power: Price mechanisms can lead to monopoly power, where a few producers control the supply of a particular good or service. This can result in higher prices and reduced choice for consumers.
Imperfect information: Price mechanisms assume that all market participants have perfect information about the market conditions. However, this is often not the case, which can lead to inefficiencies in the allocation of resources.
Short-term focus: Price mechanisms can lead to a short-term focus by producers and consumers as they respond only to the immediate changes in prices, rather than taking a long-term perspective. This can lead to unsustainable use of resources and environmental degradation.
Definition of market failure
When free market price mechanisms fail to allocate resources effectively leading to a net welfare loss for society.
Complete Market Failure
When the market does not provide the necessary products at all, ie. missing markets
Partial Market Failure
When the market functions but it supplies either the wrong quantity of a product or at the wrong price, eg. negative externalities
Key causes of market failure (9)
Public Goods - ie. the market fails to provide these goods so the Govt. must.
Inequality - There is an unequal distribution of resources.
Monopoly - A single firm dominates the market and is able to determine prices
Merit Goods - People underestimate the benefit of these goods, eg. education
Factor Immobility - such as geographical immobility
Agriculture - susceptible to volatility, eg. adverse weather
Cyclical Instability - Macroeconomy enters boom or recession
Externalities - Consumption leads to a cost/benefit to a third party
Demerit Good - People underestimate the negative costs of consumption, eg. smoking
Characteristics of a pure public good (2)
Non-rivalrous
Non-excludable
Characteristics of a private good (2)
Rivalrous
Excludeable
Characteristics of a Quasi-Public good (3)
May be rivalrous to an extent
May be excludable to an extent
Quasi-Goods may be partly finaced by the Govt.
How can the development of technology adjust the characteristics of goods ?
Technology can create barriers to public goods, giving them features of a private good.
Eg. Encrypted TV channels which require subscriptions
Free-Rider Problem
When people can benefit from a good/service without paying anything towards it.
Can lead to the tragedy of the commons
The Tragedy of the Commons
When there is a lack of private ownership, the tragedy of the commons may arise.
This assumes that producers will act in their self-interest to unsustainably exploit public goods, eg. fish, leading to a depletion of that resource.
Property Rights (definition +consequence of lack of - 2 )
The legal ownership or control of goods that can be awarded or bought by an economic agent.
A lack of property rights can lead to; 1. Tragedy of the Commons, 2. Difficulties proving collateral.
Potential solutions to the Tragedy of the Commons (3)
- Applying rules and regulation to common goods eg. shorter fishing seasons.
- Establishing cultural norms of conservation behaviours.
- Creating property rights for common goods.
