Market Failure

Question 1

Market failure

Answer 1

When consumer and producer surplus isn’t maximised and the resources aren’t allocated efficiently

Question 2

Externalities

Answer 2

Unintended side effects (positive or negative) that occur on a third party as a result of someone else’s transaction

Question 3

Marginal Private Benefit

Answer 3

The private benefit gained by a consumer from the consumption of a good or service

Question 4

Marginal social benefit

Answer 4

Marginal private benefit plus or minus any external benefit or cost on others as a result of the good being consumed by an individual

Question 5

Marginal private cost

Answer 5

The private (individual) cost to a firm that are incurred as a result of a good being produced

Question 6

Marginal social cost

Answer 6

Marginal private costs plus or minus any external benefit or cost of production on others as a result of the good being produced

Question 7

Positive externalities of consumption

Answer 7

These occur when the MSB to society is greater than the MPB in consumption

Question 8

Merit goods

Answer 8

Goods that have positive externalities of consumption

Question 9

Subsidy issues (2)

Answer 9

Cost to the government, estimating the amount of subsidy

Question 10

Direct provision issues (2)

Answer 10

Cost to government, government may not have expertise in production of good

Question 11

What is a public awareness campaign?

Answer 11

Aimed to increase the demand for a good

Question 12

What is legislation aimed at?

Answer 12

Decreasing demand to move curve closer to the MSB curve

Question 13

Negative externalities

Answer 13

When consumption of the good results in the MSB is less that MPB

Question 14

Demerit good

Answer 14

A good that results in a negative externality

Question 15

Pigouvian indirect taxes

Answer 15

Taxes on goods with negative externalities

Question 16

Issues with indirect taxes

Answer 16

• 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

Question 17

Legislation

Answer 17

Aimed at reducing the demand for a good

Question 18

Issues with legislation

Answer 18

• Takes away consumer rights
• May be difficult to inforce

Question 19

Education and awareness

Answer 19

Aimed to educate consumers about the negative externalities of a good, reducing the demand. Example of a nudge theory.

Question 20

Positive externalities of production

Answer 20

Goods where the MPC of production is greater than the MSC of production

Question 21

How can government achieve welfare gain in goods with positive externalities of production

Answer 21

Subsidies, direct provision

Question 22

Negative externalities of production

Answer 22

When the MSC is greater than the MPC of production

Question 23

Common pool resources

Answer 23

Natural resources that are impossible to stop people from using them

Question 24

Non-excludable

Answer 24

Impossible to stop people using them

Question 25

Rivalous

Answer 25

When one person uses it, the value reduces

Question 26

Tragedy of the Commons

Answer 26

When common pool resources are exploited and degraded

Question 27

6 strategies to reduce welfare loss caused by negative externalities of production

Answer 27

International agreements, specific methods ie tradable permits, carbon taxes, legislation, subsidies, giving responsibility

Question 28

Tradable permits

Answer 28

A right/allowance to use a fixed amount of a common pool resource

Question 29

Carbon tax

Answer 29

A tax imposed when fossil fuels are burned. Designed to eliminate a negative externality.

Question 30

Benefits of carbon tax

Answer 30

Consumers will use more energy efficient appliances, producers will invest in cleaner production, government will create revenue

Question 31

Implications of legislation

Answer 31

Domestic producers are less competitive, implementation takes time/money, overregulation issues

Question 32

Issues with international cooperation

Answer 32

Not all countries are committed, not enough regulation

Question 33

Public goods

Answer 33

Goods that would not be provided at all by the free market but are of benefit to society

Question 34

Examples of public goods

Answer 34

Public healthcare, roads, streetlights, national parks

Question 34

What don’t the free market provide public goods?

Answer 34

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)

Question 35

How can the government increase the supply of public goods?

Answer 35

Direct provision, public/private partnership

Question 36

Asymmetric information

Answer 36

Making a decision based on imperfect/incomplete information

Question 37

Adverse selection

Answer 37

When one party has better information than the other. The market failure occurs before the transaction.

Question 38

Adverse selection example (consumer having more info) and how to overcome

Answer 38

Health insurance - consumers must disclose health issues

Question 39

Example of producer having more info - adverse selection

Answer 39

Cigarette consumption in the 1950’s.

Question 40

How can adverse selection be overcome?

Answer 40

By government regulations ensuring you disclose any benefits/risks, by active spreading of information about the product via the internet.

Question 41

Moral hazard

Answer 41

When people take risks as the consequences will be borne by others. Market failure occurs after the transaction.

Question 42

Moral hazard example

Answer 42

Drivers with full car insurance taking more risks driving, knowing insurance will pay for any damage to their car