Market Failure Flashcards
Market failure
When consumer and producer surplus isn’t maximised and the resources aren’t allocated efficiently
Externalities
Unintended side effects (positive or negative) that occur on a third party as a result of someone else’s transaction
Marginal Private Benefit
The private benefit gained by a consumer from the consumption of a good or service
Marginal social benefit
Marginal private benefit plus or minus any external benefit or cost on others as a result of the good being consumed by an individual
Marginal private cost
The private (individual) cost to a firm that are incurred as a result of a good being produced
Marginal social cost
Marginal private costs plus or minus any external benefit or cost of production on others as a result of the good being produced
Positive externalities of consumption
These occur when the MSB to society is greater than the MPB in consumption
Merit goods
Goods that have positive externalities of consumption
Subsidy issues (2)
Cost to the government, estimating the amount of subsidy
Direct provision issues (2)
Cost to government, government may not have expertise in production of good
What is a public awareness campaign?
Aimed to increase the demand for a good
What is legislation aimed at?
Decreasing demand to move curve closer to the MSB curve
Negative externalities
When consumption of the good results in the MSB is less that MPB
Demerit good
A good that results in a negative externality
Pigouvian indirect taxes
Taxes on goods with negative externalities
Issues with indirect taxes
- On inelastic goods, less than proportionate change so Qsocial may not be reached
- Consumers may look for other sources eg blackmarket
- Affect lower income families more
Legislation
Aimed at reducing the demand for a good
Issues with legislation
- Takes away consumer rights
- May be difficult to inforce
Education and awareness
Aimed to educate consumers about the negative externalities of a good, reducing the demand. Example of a nudge theory.
Positive externalities of production
Goods where the MPC of production is greater than the MSC of production
How can government achieve welfare gain in goods with positive externalities of production
Subsidies, direct provision
Negative externalities of production
When the MSC is greater than the MPC of production
Common pool resources
Natural resources that are impossible to stop people from using them
Non-excludable
Impossible to stop people using them
Rivalous
When one person uses it, the value reduces
Tragedy of the Commons
When common pool resources are exploited and degraded
6 strategies to reduce welfare loss caused by negative externalities of production
International agreements, specific methods ie tradable permits, carbon taxes, legislation, subsidies, giving responsibility
Tradable permits
A right/allowance to use a fixed amount of a common pool resource
Carbon tax
A tax imposed when fossil fuels are burned. Designed to eliminate a negative externality.
Benefits of carbon tax
Consumers will use more energy efficient appliances, producers will invest in cleaner production, government will create revenue
Implications of legislation
Domestic producers are less competitive, implementation takes time/money, overregulation issues
Issues with international cooperation
Not all countries are committed, not enough regulation
Public goods
Goods that would not be provided at all by the free market but are of benefit to society
Examples of public goods
Public healthcare, roads, streetlights, national parks
What don’t the free market provide public goods?
Non excludable (can’t exclude people from benefitting so no price can be charged), non rivalrous (one person consuming the good doesn’t stop someone else from consuming the good)
How can the government increase the supply of public goods?
Direct provision, public/private partnership
Asymmetric information
Making a decision based on imperfect/incomplete information
Adverse selection
When one party has better information than the other. The market failure occurs before the transaction.
Adverse selection example (consumer having more info) and how to overcome
Health insurance - consumers must disclose health issues
Example of producer having more info - adverse selection
Cigarette consumption in the 1950’s.
How can adverse selection be overcome?
By government regulations ensuring you disclose any benefits/risks, by active spreading of information about the product via the internet.
Moral hazard
When people take risks as the consequences will be borne by others. Market failure occurs after the transaction.
Moral hazard example
Drivers with full car insurance taking more risks driving, knowing insurance will pay for any damage to their car
