Market Failure

Question 1

Reasons for market failure (3)

Answer 1

Externalities
Public good
Information gaps

Question 2

What is a social benefit / costs

Answer 2

Private and external benefits / costs

Question 3

What is market failure (2)

Answer 3

Demand doesn’t equal supply
Marginal social costs don’t equal marginal social benefits

Question 4

What is an externality

Answer 4

Third party spill over effects from production or consumption

Question 5

Negative production externality diagram

Answer 5

Shift MSC left

Question 6

Positive consumption externality

Answer 6

Shift MSB to right

Question 7

Type of externalities + example (4)

Answer 7

Missing market - national defence
Partial failure - healthcare

Question 8

Missing market what

Answer 8

Wouldn’t be provided without gov

Question 9

Partial failure

Answer 9

Some can afford better (private healthcare) and other can’t

Question 10

What is the social optimal level

Answer 10

Where MSB=MSC
Where society gets max benefit of positive externality whilst covering cost of negative externality

Question 11

Characteristics of neg externality (4+)

Answer 11

Overproducing
Underpricing
MSC bigger
Deadweight welfare loss

Question 12

Characteristics of positive externality (3)

Answer 12

Underconsumption
MSB bigger
Potential welfare gain

Question 13

Why does lack of property rights create externality (2)

Answer 13

Factory won’t be held accountable for waste in nearby river if no one has PR and takes responsibility
Leads to overuse of scarce resources + environmental damage

Question 14

What is a merit good (4++)

Answer 14

Good that:
Consumption benefits society
People unaware of full benefits = underconsumption + overproduction
MSB greater than MSC
Healthcare + education

Question 15

Demerit good characteristics (4)

Answer 15

Consumption considered harmful
Unaware or don’t care
Cig and drugs
Over produced + consumed

Question 16

Why are demerit and merit goods over or under consumed/produced

Answer 16

Information gaps

Question 17

Use of a subsidy to increase consumption of merit good why + diagram

Answer 17

If left to free market = market equilibrium lower than socially optimal level
Shift MPC=MSC outward to right

Question 18

Use of tax on demerit good diagram (2)

Answer 18

Shift MPC left but not as far as MSC
Reduces the deadweight welfare loss

Question 19

What is a public good (2)

Answer 19

Non excludable + non rivalrous
Under provided by free market

Question 20

What is non excludable + non rivalrous mean

Answer 20

People can’t be stopped from consuming
Someone’s consumption doesn’t affect your own

Question 21

What’s a quasi pubic good (2)

Answer 21

One or the other - excludable/rivalrous
Roads = tolls (ex) or congestion (rivalrous)

Question 22

Why - public goods = market failure (3)

Answer 22

Producers overvalue to charger higher price
Consumers under value to get lower price
Firms are reluctant to supply public goods

Question 23

Types of imperfect info (3)

Answer 23

Moral hazard
Adverse selection
Principal agent problem

Question 24

What is moral hazard (2)

Answer 24

People take risks because they don’t suffer the consequences
Example = car insurance where provider lacks info in how individual acts

Question 25

What is adverse selection (4+)

Answer 25

Company sells medical insurance
- premiums to high for people in good health
- good value for those in poor health = need lots of medical treatment which costs firm more money
- selling to unprofitable customers = financial loss

Question 26

What is PAP(3)

Answer 26

Different interests within firm
Shareholders want to maximise profits
Manager want to maximise bonuses or welfare

Question 27

Demerit/merit goods and info gaps relation (2+)

Answer 27

Closely linked
Demerit = alcohol which is over consumed because health dangers glossed over in advertising

Question 28

Example of private + then external costs for same thing (3)

Answer 28

Driving a car:
Cost of petrol + tax + buying car
Greater congestion + slower journey times for other drivers