Market Failure

Question 1

What is market failure?

Answer 1

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

Question 2

What are the three market failures?

Answer 2

• information gaps (existence)
• public goods (under-provision)
• externalities (existence)

Question 3

What is a public good?

Answer 3

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)

Question 4

What does non- rivalrous mean?

Answer 4

Non-rival is when the consumption of a good doesn’t prevent another person from also consuming that good

Question 5

What does non-excludable mean?

Answer 5

Non-excludable means that once a good is provided it is impossible to stop people from also consuming it (e.g lampposts)

Question 6

Why is there no price charged for a public good?

Answer 6

The benefits of consuming the good cannot be confirmed to the one individual that has paid

Question 7

What are the main characteristics of public goods?

Answer 7

They are non-rivalrous and non-excludable

Question 8

Which economy does not have public goods?

Answer 8

The free market economy does not have public goods - due to the free rider problem

Question 9

What are externalities?

Answer 9

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

Question 10

What are private costs/benefits?

Answer 10

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)

Question 11

What is external costs/benefits?

Answer 11

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)

Question 12

What is social costs/ benefits?

Answer 12

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

Question 13

What is a merit good?

Answer 13

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

Question 14

What is a demerit good?

Answer 14

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)

Question 15

What is a private good?

Answer 15

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).

Question 16

What is a normal/ inferior good?

Answer 16

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)

Question 17

What is the free rider problem?

Answer 17

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.

Question 18

What is the social optimum level of output?

Answer 18

It occurs when all the external benefits and costs are accounted for

Question 19

What is perfect information?

Answer 19

Perfect information is when a buyer/seller has complete understanding of the quality and nature of good/ service

Question 20

What is symmetric information?

Answer 20

When buyers and sellers have equal amounts of amounts of knowledge about/ good or service

Question 21

What is imperfect information?

Answer 21

When a buyer and/or seller lack complete understanding of the quality and nature of a good or service

Question 22

What is asymmetric informstion?

Answer 22

When a buyer or seller has more information about a good/ service than the other party.

Question 23

What is an information gap?

Answer 23

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.

Question 24

What is information failure?

Answer 24

Information failure occurs when people have inaccurate, uncertain or misunderstood data and so make potentially wrong or sub - optimal choices.

Question 25

What are the causes for market failure?

Answer 25

• misunderstanding/ uncertainty ab the true benefits/ costs
• in accurate/ misleading information
• addiction
• lack of awareness/ competition
• habitual purchase
• missing markets

Question 26

What is marginal social benefit?

Answer 26

Marginal social benefit = marginal private benefit + marginal external benefit

Question 27

What is the principal agent problem?

Answer 27

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)

Question 28

Why is it difficult to work out the size of the economy?

Answer 28

Because it tends to be Planck on value judgements, since it’s difficult to monetise external costs.

Question 29

Why are many externalities caused by information gaps?

Answer 29

Since people are unaware of the full implications of their decisions

Question 30

Why and how might government intervene in the market?

Answer 30

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

Question 31

Indirect taxes and subsidies. (Gov intervene)

Answer 31

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)

Question 32

Tradable pollution permits. (Gov intervention)

Answer 32

• 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.

Question 33

Provision of the good (gov intervention)

Answer 33

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)

Question 34

Provision of information (gov int)

Answer 34

Since the externalities are associated with information gaps

The gov may provide information to help people acknowledge external costs. (Informed decisions)

Question 35

Regulation (gov int)

Answer 35

• could limit consumption of good with negative externalities
  (E.g banning advertising of smoking etc)

Question 36

What are positive/ negative externalities?

Answer 36

• positive externalities of consumption occurs when social benefit > social cost
• negative externalities of consumption occurs when social benefit < social cost

Question 37

Minimum prices set by government

Answer 37

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)

Question 38

Maximum price set by gov.

Answer 38

Gov set max price to encourage production/ consumption of a good/ service

• it’s so the good doesn’t become too expensive