Market Failure

Question 1

Negative externalities

Answer 1

Spill-over costs borne by third parties who are not directly involved in the consumption or production of the good itself without compensation

Question 2

Government intervention correcting NE

Answer 2

Indirect tax, laws & regulations, ban, marketable pollution permits, promoting substitute markets via subsidies, public education & campaigns

Question 3

Indirect tax

Answer 3

Forces consumer/firm to internal is the external cost by imposing a tax = MEC incurred at Qs

Question 4

Laws & regulations

Answer 4

Reduces output or external costs
e.g. no smoking in certain areas

Question 5

Total ban

Answer 5

Outright restriction of output where quantity produced is now 0

Question 6

Marketable pollution permits

Answer 6

“Cap-&-trade”
If pollution can be easily monitored & polluters easily identified, may implement this to reduce pollution

Question 7

Promoting substitute markets via subsidies

Answer 7

May promote alternative market to correct NE. Incentive-based approach

Question 8

Public education & campaigns

Answer 8

Convinces public to consume less/producers to switch their methods/produce less

Question 9

Positive externalities

Answer 9

Spill over benefits enjoyed by third parties who are not directly involved in the consumption or production of the good or service itself, without payment

Question 10

Government Intervention to correct Positive Externalities

Answer 10

Subsidies, direct provision, joint provision, legislation, public education & campaigns

Question 11

Subsidies (PE)

Answer 11

Lower MPC -> encourage greater consumption/production

Question 12

Direct provision at zero price/free provision

Answer 12

Government could directly provide goods/services at socially efficient quantity (Qs) & at 0 price/free. Or pay firms to provide at Qs. e.g. vaccines

Question 13

Legislation

Answer 13

Laws -> compel -> up to socially efficient output Qs.

For goods with external benefits, government could increase consumption/production.

Question 14

Public education & campaigns (PE)

Answer 14

-> convince to consume goods with PE

Question 15

Merit goods

Answer 15

Deemed by the government to be desirable for consumption & under-consumed when left to the free market

Question 16

Demerit goods

Answer 16

Deemed by the government to be undesirable for consumption & over consumed when left to the free market

Question 17

Product complexity

Answer 17

information provided may be too complex for consumers to comprehend

Question 18

Persuasive Advertisements & Misinformation

Answer 18

Presence of highly persuasive advertisements -> over-estimate PB -> over-consumption

Question 19

User inexperience

Answer 19

Taking into account only purchase price -> underestimate true cost over time.

e.g. considering cost of car & not monthly expenses for cars like car loans

Question 20

Addiction

Answer 20

Attentional biases for substance-related stimuli. Attentional bias & craving = mutual relationship, increase in one -> increase in other

May overestimate actual benefits & underestimate actual costs

Question 21

Asymmetric information

Answer 21

Situation where one party in an economic transaction has more information than the other party. When former decides to exploit the latter, may result in the problems of adverse selection & moral hazard.

A subset of imperfect information

Question 22

Adverse selection

Answer 22

Arises when certain parties naturally select themselves out of a market, giving rise to missing markets where these parties do not get to buy or sell the good even though it may be beneficial for them to do so

Question 23

Screening

Answer 23

Economic agents gathering information to make the right decision

Question 24

Signalling

Answer 24

Sellers’ tempt to reveal credible information about what they have to sell in order to make themselves more attractive to a buyer

Question 25

Co-payments (managing moral hazard)

Answer 25

Insured person co-pays part of the actual cost -> undertake less risk-taking behaviours

Question 26

Public goods

Answer 26

Non-rejectable goods that are not provided by the free market due to non-excludability & non-rivalry in consumption

Question 27

Non-excludability

Answer 27

Once provided, no one can be excluded from consuming the good even if they do not pay

Question 28

Non-rivalry

Answer 28

Consumption of the good by one more person will not leave less for others to consume

Marginal social cost of providing the good to an additional person is 0

Question 29

Non-rejectability

Answer 29

Inability of consumers to refuse the consumption of a good once it has been provided

Question 30

Market failure

Answer 30

Occurs when the free market/price mechanism fails to bring about an efficient allocation of resources. It occurs when MSB does not equal to MSC