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microeconomics > market failure > Flashcards

market failure Flashcards

1
Q

what is market failure

A

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.

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2
Q

externalities

A

spill over effects on third parties from a private transaction- from production or consumption

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3
Q

what is allocative efficieny

A

Allocative Efficiency is the optimal distribution of goods in an economy that meets the needs of society.

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4
Q

why is market failure justified

A

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.

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5
Q

what is MPB

A

benefits and satisfaction an individual gains from consumption

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6
Q

what is MPC

A

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.

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7
Q

what is an external cost

A

A cost associated with production/economic activities that is borne by a third party.

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8
Q

what is a negative production externality

A

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

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9
Q

explain negative production externality diagram

A

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.

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10
Q

explain welfare loss

A

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.

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11
Q

positive production externalities

A

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

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12
Q

what are merit goods

A

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)

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13
Q

explain the positive externality diagram

A

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)

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14
Q

explain welfare loss with postive externalities

A

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)

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15
Q

What are Demerit goods?

A

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).

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16
Q

Common Examples
of demerit goods

A

Fast Food
Alcohol
Cigarettes & Drugs
Large Speakers
Car Ownership

17
Q

explainNegative Consumption Externality Diagram

A

Free Market Equilibrium is at Point A.

Knock on spillovers from the consumption of demerit goods are not accounted for. MSB = MPB + EC.

Free market over allocates resources to meet consumption of the good relative to the social optimum. (Qm>Qopt)

Social Optimum = Point B.

18
Q

What are Indirect Taxes

A

A tax on a good or service often aimed at reducing the quantity on the market.

Indirect Taxes & Externalities
Pollution is an external cost from producers that a Carbon Tax may address.
Operate on a ‘Polluter Pays’ principle.

19
Q

how does indirect taxes change the negative externaltiies diagram

A

Free Market equilibrium occurs at where MPC = MPB.

Vertical distance between MPC and MSC represent the external costs of production.

Q2 represents social optimum MSB = MSC.

Government intervenes by imposing an indirect tax.

Tax increases Production costs, reducing supply until MPC is in line with MSC.

Cost is internalized.

20
Q

evaluate indirect/ carbon tax

A

Difficulties measuring externality
Likelihood of undercorrection/overcorrection
Political willingness
Impact on consumers depends on consumer income (indirect taxes are regressive)
Opportunity Cost/Enforcement Costs

21
Q

explain cap and trade schemes

A

Cap & Trade Schemes AKA Carbon Trading are a relatively recent tool used by governments to curb pollution.

Market Based Policy.

Firms are given permits to ‘Pollute’ which can then be traded and sold to other firms.

22
Q

what is regulation

A

Regulation is defined as a set of rules, normally imposed by government, that firms must follow.

‘Command & Control’ approach.
Command: Ban or limit
Control: Legal Enforcement, Financial Punishment

23
Q

examples of regulations

A

Fishing Quotas
Limits on stock within time period.

Environmental Protection Act (1990)
Standards for all factories producing chemicals.

24
Q

evaluating the use of regulations

A

Advantages
Regulations can be gradually toughened/implemented over time.

Theoretically ‘Cheaper & Simpler’ to implement.

Disadvantages
High Enforcement & Opp Cost
Unintended consequences/black markets.
(Indiscriminate Instrument) Meeting regulations have a greater impact on small business.
Subject to Regulatory Capture
Deters future investment

25
Q

What is Nationalisation?

A

Nationalisation involves the transfer of industry from private ownership to state control.

State Provides a good or service.
Nationalising may reduce negative externalities or increase positive externalities.

26
Q

evaluation of nationalisation

A

Beneficial:
Better coordination with a central plan.
State can monitor externalities easily
Employees have no incentive to ‘lie’ or ‘game’ the system.

Problematic:
May deter future investment

27
Q

Subsidies & Positive Externalities

A

in a free market, people ignore the positive externalities of consumption leading to an underconsumption.

Leads to market failure which subsidies can be used to correct.

28
Q

graph analysis for subsidies on positive externalities

A

free Market Equilibrium is at point F where MPC = MPB.

Merit goods have a large external benefit, shifting MPB to MSB.

If the government provides subsidies, the supply curve shifts to S2.

cost of supplying thr good increases

Increase in Supply to S2, means new equilibrium is P3,Q2.

Q2 is the same as the social optimum quantity, just at a lower price.

29
Q

Evaluating Subsidies

A

Government relies on Tax Revenue (Opportunity Cost)
Highly political
Cost to government
Lead to subsidy dependent firms
Subsidies are less effective when PED is inelastic

30
Q

Inflation Reduction Act

A

joe Biden landmark piece of legislation that aimed to reduce inflation, reduce the budget deficit, reduce drug prices, and increase clean energy production.

Subsidies* for energy firms.

*Tax breaks for investing into green technology.

31
Q

give examples of alternative interventions

A

Subsidies are the main way consumption/production of merit goods can be increased.

Other interventions could include:
Legislation
Advertising/Information
Direct Provisioning

32
Q

what is legislation

A

Legislation can be used to require consumption of merit goods.

E.g. Compulsory Education, Vaccinations

The demand curve (MPB) therefore shifts outwards until it reaches the MSB curve.

33
Q

problems with legislation

A
  • legislation can be regressive, forces them to purchase can have an impact on their disposable income
  • can lead to lobbying (political lobbying)
34
Q

advertising impacts

A

Governments can use advertising campaigns to persuade or nudge consumers to buy merit goods.

35
Q

examples of advertising

A

Vaccine nhs adverts, TFL & Public transport adverts

36
Q

what is direct provisioning

A

Government may nationalize an entire industry or start providing merit goods themselves.

E.g. Virtually all countries in the world provide education and health care due to external benefits.

37
Q

explain direct provisioning diagram

A

Supply is inelastic as state decides the level of output to market.

When the state makes the good/service free to consumers, there will always be excess demand.

E.g. NHS

38
Q
A

microeconomics (10 decks)

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