Market Failure Flashcards
Market Failure definition
When Market forces (Supply + Demand) fail to allocate resources efficiently.
- Due to Price Mechanism not taking into account the costs / benefits properly
Explain why Market Failure might occur? + 4 reasons for this?
- For efficient allocation of resources the Social Marginal Costs (SMC) need to be equal to the Social Marginal Benefits (SMB)
–> in practise some SMC or SMB may not be included as they are not known or hard to quantify - Externalities, Non-Provision of public goods, Information Gaps, Immobility of Labour
What is Social Marginal Costs and Social Marginal Benefits
Social Marginal Costs - SMC
- Addition to total Cost of producing an extra unit of output
Social Marginal Benefit - SMB
- Addition to total benefits of consuming an extra unit
What is an Externality? + the two types?
- Cost or benefit to a third party, who are not directly involved in production or consumption
- External Costs (Negative Externalities)
- External Benefits
What are Private Costs?
Costs paid directly by the producer and consumer in a transaction
- Private Costs of Producer –> e.g. wages, rent, raw materials
- Private Costs of Consumer –> e.g. Price paid for product / service
Define External Costs (Negative Externalities) + examples of Negative externalities of production + consumption.
Costs of transaction to third parties
- Costs from production or consumption the market fails to take into account
Production
e.g. air pollution, noise pollution, deforestation
Consumption
e.g. passive smoking, overeating’s effect on NHS / taxpayers
What are Social Costs?
Social costs = Private costs + External costs
–> External Costs = Social - Private
Draw + Explain a Negative Externality Diagram?
PMB = SMB (Private Marginal Benefit equal Social Marginal Benefit –> the same line (in place of normal D curve)
PMC (Private Marginal Cost –> in place of normal S curve)
SMC (Social Marginal Cost –> inwards + steeper gradient than PMC)
- PMB is demand curve - indicates private Benefits to consumer decrease as consumption increases
–> assumed no external benefits so PMB = SMB - PMC is Supply curve - indicates private costs of providing product rise as output rises
- In free Market economy, equilibrium at point PMB=PMC (Label X)
- in Social optimum level (X) is not equilibrium as takes no account of negative externalities
- SMC includes private costs + external costs (drawn to left of PMC)
–> Socially optimal level of output @ equilibrium where SMC = SMB (Y)
–> Triangle created (from X point up) is the welfare loss from over-production + over-consumption
What are Private Benefits? + examples to Producer / Consumer?
Benefits received directly by the producer and consumer in a transaction
Priv. Benefit to Producer –> Revenue from sale
Priv. Ben to Consumer –> utility (satisfaction) gained from consumption
Define Positive Externalities (External Benefits) + e.g. to consumption + production
Positive externalities benefits to third parties not directly involved in the transaction.
–> benefits market fails to account for
Positive externality of consumption
e.g. vaccinations prevent spread of disease to others, education helps boost GDP of whole country
Positive externalities of production
e.g. Farmer making honey with bees –> bees pollinate surrounding crops
Firm trains worker in computer skills —> other firms benefit from skilled workers
What are Social Benefits?
Social Benefits = Private Benefits + External Benefits
–> External Benefits = Social - Private
Draw + Explain a Positive Externality Diagram?
PMB (Private Marginal Benefits) in place of Demand Curve
–> (indicates Private Benefits to consumer ↓ as Consumption↑
PMC = SMC (Private Marginal Costs = Social Marginal Costs –> in place of Supply curve)
- In free Market econ equilibrium at PMB = PMC (Label X)
- X is not socially optimum level output as does not account for Negative externalities of production
-SMB curve includes private + External benefits (Right of PMB) - Social optimal level output is at equilibrium SMC = SMB (Label Y)
–> Welfare Gain is triangle going up from X
–> Free Market would cause under-consumption + production
Public Goods vs. Private Goods + e.g.
Public Goods
- Non-Rivalrous ( One persons use does not limit other persons use)
- Non-Excludable (Cannot prevent anyone from consumption)
e.g. National Defence, Street Light, National Parks
Private Goods - Rivalrous + Excludable
What is the Free Rider Problem
Due to Public Goods being Non-Excludable
–> People able benefits from it without paying
Can cause Market Failure as insufficient payment for product means its not a profitable for private business to provide
Symmetric Vs. Asymmetric Information + why this can cause market failure + e.g’s
- Asymmetric - where one party in transaction has more information compared to the other
- Free Market based on assumption consumers + producers make rational choices based on perfect (symmetric) information
Asymmetric information causes resources to be allocated inefficiently –> results in market failures
e.g.
- Second-hand car sales, High-tech Products, Life insurance
