Market Failure Flashcards
What is market failure?
Market failure is when the price mechanism fails to allocate scarce resources efficiently or when operations of the market forces lead to net social or welfare loss
What are the three market failures?
- information gaps (existence)
- public goods (under-provision)
- externalities (existence)
What is a public good?
A public good refers to a commodity or service that is made available to all members of society (they are non-rivalry and non-excludable)
What does non- rivalrous mean?
Non-rival is when the consumption of a good doesn’t prevent another person from also consuming that good
What does non-excludable mean?
Non-excludable means that once a good is provided it is impossible to stop people from also consuming it (e.g lampposts)
Why is there no price charged for a public good?
The benefits of consuming the good cannot be confirmed to the one individual that has paid
What are the main characteristics of public goods?
They are non-rivalrous and non-excludable
Which economy does not have public goods?
The free market economy does not have public goods - due to the free rider problem
What are externalities?
Externalities refers to situations when the effect of production/ consumption of goods/services imposes costs or benefits on others which are not directly involved in the transaction
What are private costs/benefits?
Private costs/benefits are the costs/benefits to the individual that is directly involved in the making/ buying/ selling/ consumption of a specific good/ service.
(demand curve = private benefits)
(Supply curve = private costs)
What is external costs/benefits?
A cost/ benefit to a third party that isn’t involved in the making/ buying/ selling or consumption of a specific good/ service.
(Not involved in economic transactions)
What is social costs/ benefits?
Social costs/ benefits are the costs/ benefits of an activity to society as a whole.
Social benefit = Private benefit + external benefit
Social cost - private cost + external cost
What is a merit good?
A merit good is a good with external benefits, where the benefits to society > benefits to the indivisual
(Tends to be under-provided by the free market)
- merit goods are commodities that the public sector provides cheaply or free of charge to encourage production
What is a demerit good?
A demerit good is a good with external costs, where the costs to society > the costs to the individual
(Tend to be over-provided by the free market)
What is a private good?
A private good is a product that must be purchased to be consumed (excludable) and consumption of one individual prevents another individual from also consuming it (rivalrous).
What is a normal/ inferior good?
A normal good is a good that has an increase in demand when income rises
An inferior good is a good that has a decrease in demand when income rises (e.g buses)
What is the free rider problem?
It is a type of market failure that occurs because everybody is able to benefit from the public good.
- and while not paying for the good and still using it there will be no revenue generated, which causes a loss of money
so if the good is available it will either be
- under-provided
- not provided at all
- underprovision of public goods are one of the causes of market failure.
What is the social optimum level of output?
It occurs when all the external benefits and costs are accounted for
What is perfect information?
Perfect information is when a buyer/seller has complete understanding of the quality and nature of good/ service
What is symmetric information?
When buyers and sellers have equal amounts of amounts of knowledge about/ good or service
What is imperfect information?
When a buyer and/or seller lack complete understanding of the quality and nature of a good or service
What is asymmetric informstion?
When a buyer or seller has more information about a good/ service than the other party.
What is an information gap?
An information gap is when either the buyer or seller does not have access to the information needed for them to make a fully - informed decision.
What is information failure?
Information failure occurs when people have inaccurate, uncertain or misunderstood data and so make potentially wrong or sub - optimal choices.
What are the causes for market failure?
- misunderstanding/ uncertainty ab the true benefits/ costs
- in accurate/ misleading information
- addiction
- lack of awareness/ competition
- habitual purchase
- missing markets
What is marginal social benefit?
Marginal social benefit = marginal private benefit + marginal external benefit
What is the principal agent problem?
It’s when the goals of the principle (the person who gains/ loses from the decision) are different from the agents (those making decisions on behalf of the principles)
Why is it difficult to work out the size of the economy?
Because it tends to be Planck on value judgements, since it’s difficult to monetise external costs.
Why are many externalities caused by information gaps?
Since people are unaware of the full implications of their decisions
Why and how might government intervene in the market?
Gov intervene to ensure the market considers the external costs and benefits.
- indirect taxes & subsides
- tradable pollution permits
- min/ max prices
- provision of the good
- provision of information
- regulation
Indirect taxes and subsidies. (Gov intervene)
Taxes can be put on goods with negative externalities
Subsidies put on goods with positive externalities
(These help to internalise the externalities, moving production closer to the social optimum position)
Tradable pollution permits. (Gov intervention)
- these allow firms to produce up to a certain amount of pollution
- they can also be traded amongst firms to give them choice whilst reducing the total level of pollution.
Provision of the good (gov intervention)
When social benefits are very high, the gov may decide to provide the good through taxation (e.g they do this with healthcare and education)
Provision of information (gov int)
Since the externalities are associated with information gaps
The gov may provide information to help people acknowledge external costs. (Informed decisions)
Regulation (gov int)
- could limit consumption of good with negative externalities
(E.g banning advertising of smoking etc)
What are positive/ negative externalities?
- positive externalities of consumption occurs when social benefit > social cost
- negative externalities of consumption occurs when social benefit < social cost
Minimum prices set by government
Gov set min prices to discourage production/consumption of a good
- it makes sure the good never falls below a certain price (make it expensive)
Maximum price set by gov.
Gov set max price to encourage production/ consumption of a good/ service
- it’s so the good doesn’t become too expensive
