Market Failure

Question 1

Allocative efficiency

Answer 1

Efficient allocation of resources
MSB=MPB = MSC=MPC
Maximisation of society surplus
Maximisation of net social benefit
Resources perfectly follow consumer demand

Question 2

Assumptions of allocative efficiency

Answer 2

Many buyers
No barriers to enter the market
Firms maximise profits
Consumers maximise utility

Question 3

Public goods

Answer 3

Non-excludable-benefit of the good is not constrained to the person who pays for it. There is no cost efficient way of allocating price
Non-rival-the consumption of the good does not diminish the benefit for the next consumer
Examples-road signs, street loghts

Question 4

Free rider problem and what it leads to

Answer 4

Consumers will not pay for the provision of the good as they will wait for others to pay, if no one pays there will be no incentive for firms as there is no profit so there will be market failure

Question 5

Quasi public goods

Answer 5

Semi excludable and semi rival

Question 6

Merit goods

Answer 6

Goods deemed more beneficial by consumers than they realise
Imperfect information-info failure:not clear, not there, ignore. Asymmetric information- information not passed down to consumer
Usually positive externalities in consumption
E.g. healthcare, education, exercise
MSB>MPB

Question 7

Demerit goods

Answer 7

Goods that are deemed more harmful to the consumer than they realise
Imperfect information-info failure: not clear, not there or ignored. Assymetric info: information is there but it is not passed down to the consumer
Examples:smoking, alcohol, gambling
MPB>MSB

Question 8

What is government failure and what does it lead to

Answer 8

Government failure is when the costs of intervention outweigh the benefits, leads to the worsening of the misallocation of resources and a greater welfare loss

Question 9

Types of government failure

Answer 9

Valuing intervention
There may be information failure so it is difficult to allocate correct level of intervention
Costs of administration
-subsidies
-regulation
Unintended consequences:
Black markets
Employment
Inequality

Question 10

Positive externalities in consumption

Answer 10

When there is a positive spill over effect to third parties from the actions of consumers
Examples are exercise, healthy diet and education
MSB>MPB
there is self interest- don’t consider full social benefit
There is an underconsumption of resources
There is a misallocation of resources

Question 11

Positive externalities in production

Answer 11

When there is a positive spill over effect to third parties following the actions of producers
This could be training programmes at work or being more innovative
MPC>MSC
self interest from firms
Underconsumption/production
Misallocation of resources

Question 12

Negative externalities in consumption

Answer 12

When there is a negative spill over effect to third parties from the actions of consumers
MSB<MPB
examples are poor diet, alcohol, smoking, gambling
There is self interest
A misallocation and overconsumption

Question 13

Negative externalities in production

Answer 13

When there is a negative spill over effect to third parties following the actions of producers
Examples are air pollution, deforestation and depletion of resources
MSC>MPC
Overproduction
Self interest and misallocation of resources

Question 14

Merit goods

Answer 14

Goods that are deemed more beneficial to consumers than they realise
This is due to imperfect information: information failure or asymmetric information
They are usually positive consumption externalities
MSB>MPB

Question 15

Demerit goods

Answer 15

Goods that are deemed more harmful to consumers than they may realise
Imperfect information, most likely due to assymetric information
They are usually negative externalities in consumption
MPB>MSB

Question 16

Ways to solve market failure

Answer 16

Indirect tax, subsidy, regularion, direct provision, information provision, traceable pollution permits, maximum and minimum prices

Question 17

Indirect tax and market failure

Answer 17

An indirect tax is a tax that increases the cost of production but it can be moved onto the consumer
They: increase the cost of production, internalise the externality, resolve the issue of overproduction/overconsumption and there is allocative efficiency and tax revenue(distance between the two supply curves)
However
It depends on the elasticity (demand/supply)
It is diffuse to value the externality
There may be unintended consequences such as black markets

Graph- negative externalities
On production, they move it to MSC = MPC + TAX
On consumption, they ,over it left the q star and call it mpc + tax

Question 18

Subsidy and market failure

Answer 18

A subsidy is a money grant to producers by the government to decrease the price of goods and encourage an increase in output
Decreases cost of production
Decreases price and quantity
Resolves the issue of underconsumption or under production
There is a welfare gain and allocative efficiency
However:
It can be costly and affect the governments finances
It is difficult to value the externality so there may be government failure
It depends on the elasticity

Question 19

Regulation and market failure

Answer 19

A regulation is a law/rule enacted by the government that must be followed by economic agents to encourage a change in social behaviour
It is a non-market approach to market failure
It is done by command-caps, bans, limits, compulsory and control-enforcement and punishment
It provides an incentive to change behaviour
It solves the issue in the free market
It leads to allocative efficiency and a welfare gain
But
It may be costly
It is difficult to value the externality
There may be unintended consequences (black markets and equity)

Question 20

Tradeable pollution permits

Answer 20

Government determines where q star is, the allocate to firms tradeable pollution permits, they then decide what to do with these permits, there is then enforcement and a reduction in pollution. Lr incentive to invest into green energy, due to the lower permit burden
Problems
Requires international cooperation, it requires enforcement and it is difficult to value the externality

Question 21

State provsision

Answer 21

Direct provision of goods and services from the government where the consumer price is zero
Governments determine adequate price
There is no more underconsumption and an efficient allocation of resources

Excess demand
Valuing externality
Costly

Question 22

Maximum and minimum pricing

Answer 22

Min price, above equil will discourage demand and lead to lower quantity efficient allocation of resources
However
In elastic demand
Regression
Black markets and valuing the externality

Opposite for max pricing
Shortage
Valuing externality etc.

Question 23

Information provision

Answer 23

This is information provision funded by the government to encourage or discourage demand
Costly, may not be effective, difficult to value the externality

Question 24

How does the data show the externality is being internalised

Answer 24

Internalised-factored into the cost of production
As the externality is being internalised the price will go up