Market Failure

Question 1

What causes market failure?

Answer 1

When the Free Market fails to allocate resources efficiently, MSB ≠ MPB, MSC ≠ MPC (the market is not at its socially optimum point)

Question 2

What is an ‘Externality’?

Answer 2

The impact on a third party (usually society) outside of a private transaction

E.g The impact on society of people buying cigarettes

Question 3

What is a negative externality?

Answer 3

When the marginal social cost is greater than the marginal private cost. There is a negative impact on the third party due to the overconsumption of a (usually demerit) good

Question 4

What is a positive externality?

Answer 4

When the marginal social benefit is greater than the marginal private benefit. There is a negative impact on the third party due to the underconsumption of a (usually merit) good

Question 5

How can a government solve a negative externality?

Answer 5

• Ad Valorem Tax (+%)
• Flat Tax (+£x)
• Minimum Pricing
• Maximum Pricing

Question 6

How can a government solve a positive externality?

Answer 6

• Subsidies
• Consumer Incentives

Question 7

What are the characteristics of a public good?

Answer 7

• Non Rival
• Non Excludable
• Non Rejectable

E.g A Street Lamp

Question 8

Why do governments tend to provide public goods?

Answer 8

• Would not be produced by the private sector due to no profit incentive
• Free Rider problem

Question 9

What does non-excludability mean?

Answer 9

Benefits derived are not confined to those who pay for it

Question 10

What does non-rivalry mean?

Answer 10

Consumption of a good from one individual does not limit consumption of a good from another