Market Failure

Question 1

What is market failure

Answer 1

• Where resources are
  ineffectively allocated due to
  imperfections in the working
  of the market mechanism

Question 2

Causes of market failure - Merit & Demerit goods

Answer 2

• All societies make judgements as to which products and services are desirable or undesirable
• If markets were left by themselves these “social” valuations might be ignored
• Sales of illegal substances might increase if their supply was left to the market. Conversely, as there is little profit in providing health care to the poor, their needs might be ignored
• Goods and services such as these which a society may judge to be “good” or “bad” are classified as merit and demerit goods.

Question 3

Public goods

Answer 3

• Whilst merit goods will be underprovided if left to market forces, public goods may not be supplied at all
• because it is difficult to identify who benefits from public goods and to stop those who do not directly pay for them from being able to consume them
• For example, it would be difficult to charge people directly for the benefit they receive from street lighting.
• In addition, the benefit people gain from the light would not be reduced by more people walking down the road.

Question 4

Monopolies

Answer 4

• A monopolist would produce less and more expensively than would be the case if there were a number of producers competing against each other.

Question 5

Externalities

Answer 5

• An externality is a cost or benefit which is external to an exchange
• It is a cause of market failure since the price mechanism fails to take account of such costs and benefits in the production and consumption of a good or service.
• Externalities are also known as indirect costs and benefits since people who are not part of a transaction are affected