market failure Flashcards
rationing function
Rationing function: increasing prices rations demand to those most able to afford a good or service.
signalling function
Signalling function: prices provide important information to market participants.
incentive function
Incentive function: prices create incentives for market participants to change their actions.
market failure
Market failure: when the free market leads to a misallocation of resources in an economy.
Complete market failure
Complete market failure: when the free market fails to create a market for a good or service, also referred to as a missing market.
partial market failure
Partial market failure: when a market for a good or service exists, but it is consumed or produced in quantities that do not maximise economic welfare.
public good
Public good: a good that is non-excludable and non-rival in consumption.
non-excludable
Non-excludable: where it is not possible to prevent non-paying customers from consuming a good.
non-rival
Non-rival: where one person’s enjoyment of a good does not diminish another person’s enjoyment of the good.
private good
Private good: a good that is rival and excludable in consumption.
free-rider problem
The free-rider problem
Public goods are an example of complete market failure, as the free market would have no incentive to provide them. For example, in the case of sea defences such as flood protection, coastal homeowners would have an incentive to wait for their neighbours or others in a similar situation to fund the flood protection and thus it will not be provided at all. This is referred to as the free-rider problem, since individual consumers hope to get a ‘free ride’ without paying for the benefit they enjoy.
Quasi-public good
Quasi-public good: a good which exhibits some, but not all, of the characteristics of a public good, i.e. it is partially non-excludable and/or partially non- rival.
externality
Externality: a knock-on effect of an economic transaction upon third parties.
positive externality
Positive externality: a positive knock-on effect of an economic transaction upon third parties, also known as an external benefit.
positive externalities in production
this case, it is said that the private costs to the firm are greater than the costs to society (diagram)
positive externalities in consumption
Positive externalities in consumption occur when the actions of an individual consumer have positive knock-on impacts on others in society
negative externalities in consumption
Negative externalities in consumption
In this situation individuals consume ‘too much’ of a product, as shown in Figure 8.4, and the benefits to the individual consumer exceed the benefits to society. In the case of goods such as less-healthy foods, alcohol, tobacco and drugs, individual consumers/users fail to appreciate that society may not benefit as much from their consumption. Indeed, information failure may explain some of the over-consumption of such goods if people become intoxicated or addicted and less able to make ‘rational’ decisions. Thus there is overlap with the concept of demerit goods.
negative externalities in production
Negative externalities in production
Negative externalities in production may arise if a firm fails to take into account the wider negative impacts of their activities upon society, i.e. there are external costs. A coastal oil refinery not obliged to account for its wider impact may pollute the atmosphere and local beaches with its emissions and waste products. This will clearly have negative consequences for groups beyond the owners of the factory, including health and environmental consequences. In these situations, social costs exceed the private costs of production (such as raw materials and wages). The market failure arises because output is greater than the social optimum and the price is too low to take full account of all costs of production, including external costs, as shown in Figure 8.3.
