Market Failure

Question 1

define a positive externality

Answer 1

This occurs when the consumption or production of a good causes a benefit to a third party.

A farmer who grows apple trees provides a benefit to a beekeeper. The be

Question 2

define social benefit

Answer 2

With positive externalities, the benefit to society is greater than your personal benefit.
Therefore with a positive externality the Social Benefit > Private Benefit

Remember Social Benefit = private benefit + external benefit.

Question 3

define a negative externality

Answer 3

Negative externalities occur when the consumption or production of a good causes a harmful effect to a third party.

examples :
loud music
pollution
congestion (traffic)

Question 4

what is a social cost

Answer 4

Social cost is the total cost to society; it includes both private and external costs.

With a negative externality the Social Cost > Private Cost

Question 5

charecteristics of a merit good

Answer 5

People do not realise the true personal benefit. For example, people underestimate the benefit of education or getting a vaccination.
Usually, these goods also have a positive externality.

Therefore in a free market, there will be under consumption of merit goo

Question 6

merit good examples :

Answer 6

health care
museums
eating fruit and vegetables
education

Question 7

define charecteristics of a demerit good :

Answer 7

A good which harms the consumer. For example, people don’t realise or ignore the costs of doing something e.g. smoking, drugs.
Usually, these goods also have negative externalities. If you smoke you harm yourself, but also the smoke negatively affects other people.

Therefore in a free market, there will be overconsumption of these goods

Question 8

examples of a demerit good :

Answer 8

smoking
drinking
taking drugs
drinking sugary soft drinks
all damage health

Question 9

value judgement on merit and demerit goods

Answer 9

Merit and demerit goods involve making a value judgement that something is good or bad for you. Classification is not always straightforward. For example:
canabis
contraception

Question 10

define a public good

Answer 10

Non-rivalry: This means that when a good is consumed, it doesn’t reduce the amount available for others.
– E.g. benefiting from a street light doesn’t reduce the light available for others but eating an apple would.
Non-excludability: This occurs when it is not possible to provide a good without it being possible for others to enjoy. For example, if you erect a dam to stop flooding – you protect everyone in the area (whether they contributed to flooding defences or not.

is often under provided as there are no incentives to pay for these good

Question 11

free rider problemm

Answer 11

The problem with public goods is that they have a free-rider problem. This means that it is not possible to prevent anyone from enjoying a good, once it has been provided. Therefore there is no incentive for people to pay for the good because they can consume it without paying for it.

therefore it is normally provided for through taxation

Question 12

examples of public goods

Answer 12

national defence
street lighting
police services
flood services
internet
bridges

Question 13

quasi public goods

Answer 13

These are goods which have an element of non-excludability and non-rivalry. Roads are a good example. Once provided most people can use them, for example, those who have a driving licence. However, when you use a road, the amount others can benefit is reduced to some extent, because there will be increased congestion.

Question 14

what is market provision of public goods ?

Answer 14

Although classical economic theory suggests public goods will not be provided by a free market, there are cases when groups of individuals can come together to voluntarily provide public goods.

this is due to behavoural incentives / economics meaning individuals hav

Question 15

information asymmetries

Answer 15

where one party has access to information that another party doesn’t. For example, the seller of a car may know it has some problem, but the buyer may not be aware.

Question 16

failure to disclose information

Answer 16

In many economic transactions, agents may not make full disclosure. For example, when applying for health insurance, you may fail to inform the insurer about genetic traits or your current ill health. When purchasing financial assets, the buyer may not be aware of the risk involved. This was an issue in the period before the credit crunch. This leads to information asymmetries

Question 17

difficulty estimating costs and benefits

Answer 17

It is often difficult to be aware of social costs of goods. Accounting costs are relatively easy to know. But, when it comes to knowing more intangible external costs, it becomes difficult to put an accurate figure.

Question 18

lack of education / awareness

Answer 18

Merit and demerit goods have degrees of information failure with consumers unaware of the true personal cost/benefit. For example, if we take tobacco, there was a time when many people were not aware of the ill-effects of tobacco on health. Recently, there has been increasing concern about the health costs of sugar consumption. Many consumers are unaware of
the amount of sugar in processed food
The harmful effects of sugar on health.

Question 19

framing issues

Answer 19

When making decisions over whether to purchase a good, consumers will be influenced by how the good is portrayed.

Question 20

moral hazard

Answer 20

This occurs when individuals alter their behaviour because of certain guarantees.

For example, an insurance firm may be willing to offer insurance against

Question 21

irrelevent information / misinformation

Answer 21

If you are applying for a job, a firm may search on the internet and find a Facebook post from several years ago. The employer may use this and avoid giving job – even though it is no longer relevant to who you are now. Alternatively, there may be false information/slander circulated which is hard to deny.

Question 22

information bias

Answer 22

The government has set up regulators to deal with natural monopolies, e.g. gas and electricity. The regulator aims to set fair prices for industry and consumers. However, if they rely on information from the firm, they may become sympathetic to the firm and allow price rises. This is known as regulatory capture – where regulators act in a favourable way to the firm they are regulating.