market failure Flashcards
what is market failure
n a free market, market forces decide the allocation of resources in society.
Sometimes, market forces get it wrong and the allocation of resources (From a societal view) is not optimum.
This is called Market Failure
E.g. society might produce too much leading to environmental issues, or inequality.
externalities
spill over effects on third parties from a private transaction- from production or consumption
what is allocative efficieny
Allocative Efficiency is the optimal distribution of goods in an economy that meets the needs of society.
why is market failure justified
Market Failure is used as a justification for for government intervention in markets.
If there is misallocation of resources, the government will wish to correct is to the socially optimum.
what is MPB
benefits and satisfaction an individual gains from consumption
what is MPC
MPC are the production costs faced by the firms. MArket failure is when this isnt achieved
A cost incurred as part of the production process by a firm.
what is an external cost
A cost associated with production/economic activities that is borne by a third party.
what is a negative production externality
When production of a good or service has harmful external impacts on third parties.
Examples include:
Energy Production & Air Pollution
Farming & Water Pollution
Construction & Biodiversity/Scenery
Overworking & Mental Stress
explain negative production externality diagram
Free Market Equilibrium is Pe,Qe.
Negative spillovers from the production process have external costs which are not accounted for (represented by MSC).
Social Optimum is where MSC = MSB at Popt,Qopt.
Free market overproduces relative to the social optimum. Qe>Qopt
A market where q opt is prodcued would be the best outcome for society.
explain welfare loss
Output beyond the social optimum leads to higher costs and lower benefits for society, resulting in welfare loss.
At Qe, the MSC>MSB which is socially inefficient.
Welfare Loss is the shaded triangle between Qopt & Qe.
positive production externalities
Individual producers do not realise the positive externality they are releasing on society and therefore produce a level of output below the socially optimal level.
Positive Production Externalities
Scientific Research
Construction of Transport Infrastructure
Technology firms improving productivity
what are merit goods
Merit goods are goods/services which have positive consumption externalities, but are often underproduced by the free market leading to market failure.
Education
Health
Electric Vehicles (EV)
explain the positive externality diagram
Free Market Equilibrium is at PeQe.
Positive spillovers from consumption goods, shifts MPB to MSB.
Social Optimum is where MSB = MSC leading to Qopt being the desired amount.
Free market under allocates relative to the social optimum. (Qe>Qopt)
explain welfare loss with postive externalities
Free market output level at Qe is below the social optimum (Qopt) which leads to a loss of Social Benefits.
Welfare Loss is the shaded triangle area between these. (of diagram)
What are Demerit goods?
Demerit goods are goods which (in large quantities) are undesirable to society.
Often overproduced by the free market leading to market failure (Negative Consumption Externalities).