Market Failure Flashcards
Market Failure
When the price mechanism fails to allocate scarce resources efficiently or when the operation of free-market forces lead to a net social welfare loss due to asymmetric market info and power
Negative externalities
Costs to third parties and bystanders as a result of the action of producers or consumers, like air pollution, deforestation, smoking, excessive alcohol
Positive externalities
Benefits to third parties and bystanders as a result of the actions of producers and consumers, like healthcare, education, research and development.
Merit Goods
Goods deemed more beneficial to consumers than they realise from imperfect information causing positive externalities in consumption. Examples could be education, healthcare, exercise
De-merit Goods
Goods deemed more harmful to consumers than they realise due to imperfect information causing negative externalities in consumption. Example could be cigarettes, alcohol, gambling
Externalities in relation to the market
Effects which lie outside the initial market transaction and (without state intervention) they are not reflected in the market price
Private Costs
Internal costs faced by the producer or consumer directly involved in a transaction
External costs
When the activity of one agent has a negative effect on the well-being of a third party
Public goods
Non-excludable, Non-rival, Non-rejectable. Not normally provided by the private sector as no profit would be produced and no efficient way to price.
Non-excludable public goods
Benefits derived from a pure public good cannot be confined solely to those who’ve paid for it. Non-payers enjoy the benefits at no financial cost- ‘free rider problem’
Non-rival public goods
Each individual benefit of the good/service does not diminish other benefits, the marginal cost of supplying a public good to an extra person is zero. If supplied to one person, it is available to all
Non-rejectable public goods
The collective supply of a pure public good for all means that it cannot be rejected by people, like sunshine or the national nuclear defence system
Private goods
Owners can exercise private property rights, preventing others from using the good or consuming its benefits. A pure private good is excludable and rival
Quasi-public goods
A good which isn’t fully non-rival and/or is possible to exclude people from consuming the product, however it can be difficult or costly. An example is roads with electronic pricing
Free rider problem
Someone who benefits without paying as a result of non-excludability. Customers who choose not to pay for a good, preferring others to contribute to the provision of a public good and ‘free ride’ of those contributions. As a result the incentive to provide the good disappears leading to market failure and causing social inefficiency
State provision
May help to prevent under-provision and under-consumption of a public good so that social welfare is improved for more efficient economies of scale. However if the gov. becomes a monopoly provider there is a danger of a lack of efficiency, innovation and invention
Consumer surplus
The difference between the total amount that consumers are willing and able to pay for a good or service and the total amount they actually do pay. Shown by the area under the demand curve and above the market price
PeD with consumer surplus
Low PeD means a high level of consumer surplus because some buyers a willing to pay a very high price to continue consuming the product. A change in PeD will cause a large difference in quantity demanded, therefore less people were willing to pay with a difference in price so consumer surplus is low
Producer surplus
The difference between the price producers are willing and able to supply a good or service and the price they actually receive. Shown by area below market price and above supply curve. Lower supply costs or an increase in market demand causes a rise in producer surplus
Complete market failure
A market fails to function at all and a missing market results (market does not exist)
Partial market failure
A market does function, but it delivers the ‘wrong’ quantity of a good or service which results in resource misallocation
Missing market
There is no market because the functions of prices have broken down
Factor immobility
When a factor of production cannot move easily from one region of an economy to another, usually labour
When does private benefit maximisation occur
When marginal private benefit (MPB) = marginal private costs (MPC)
When does social benefit maximisation occur
When marginal social benefit (MSB) = marginal social cost (MSC)
Social benefits and costs
Social benefits are private benefits + any positive externalities and Social costs are private costs + any negative externalities.
If social benefits/costs exceed private benefits/costs then there are externalities
Moral hazard
A situation where one party is willing to take more risks because they know that they will not bear the full consequences of their actions.
