Market Failure Flashcards
Market failure
When the price mechanism fails to allocate resources effectively and society suffers
Externality
The effect on a non participating third party
Positive externality
Creates positive benefits to a third part like:
Producing military equipment improves technology in society
Someone training as a doctor as they benefit people in society once trained
Negative externality
Creates negative benefits to a third party like:
Steel factory produces pollution harmful to society
A chocolate bar if the wrapper is dropped on the street as litter
Social cost
Full cost to society of a good, private cost + external cost
Social benefit
Full benefit for society from the good, private benefit + external benefit
What does it mean if MPC and MSC curves are parallel
The external costs per unit produced are constant
What does it mean if MPC and MSC curves diverge
External costs increase per unit increase with output like pollution
What is the equilibrium point
Marginal private costs equal marginal private benefits
What is the social optimum point
Marginal social costs equals marginal social benefits
Overproduction
More is produced and sold at a lower level than is desirable for society , marginal social cost is greater than marginal social benefit which creates a welfare loss.
Underconsumption
Less is consumed and sold at a lower price than is desirable for society, marginal social benefit is greater than marginal social cost which creates potential welfare gain.
Public goods two characteristics
Non excludable - people can’t be stopped from using the good even if they haven’t payed
Non rivalry - one person benefiting from the good doesn’t stop another person, zero marginal cost
Private good
Excludable and exhibit rivalry, most goods are this
Quasi public good
These are goods that exhibit the characteristics of a public good, roads as they can be toll roads or become congested
Free rider problem
- impossible to stop people benefiting from a from a public good even if they haven’t paid for it
- price mechanism cannot work if there are free riders as some consumers won’t pay others will
- producers will overvalue public goods in order to increase price but consumers will undervalue to decrease price, firms will be reluctant to supply public goods
Tragedy of the commons
People acting in their own best interest will overuse and deplete a common resource, causes of environmental Market failure.
How does imperfect information affect consumption of goods
Merit goods are under consumed as people won’t know the full personal benefit and demerit goods over-consumed as people don’t know the harm of demerit goods.
How does imperfect information affect provision of goods
Merit goods will be under provided and demerit goods over provided like a doctor using their greater knowledge of medicine to sell more expensive care to clients
Three Types of Market failure
- Goods have negative and positive externalities which leads them to being over and underproduced
- Under provision of public goods as these aren’t profitable
- Information gaps mean economic agents don’t always make rational decisions
Private costs/benefits
The cost/benefit to the individual taking part in the economic activity
External costs/benefits
The cost/benefit to the non participating third party
What is MPB/MPC
The extra benefit or cost to the individual from consuming one extra unit of a good
What is MSB/MSC
The extra benefit or cost to society from consuming one extra unit of a good
