Market Failure

Question 1

Define “technical efficiency”

Answer 1

When firms pursue the least cost method of production, where firms produce at minimum average cost

Question 2

Define allocative efficiency

Answer 2

When resources are allocated to its best use

Question 3

Define 2 characteristics of public goods

Answer 3

1. Non-rivalrous - jointly consumed by people without reducing the amount available to others, many people can consume the goods at the same time
2. Non-exclusive - good or services can be used by people who do not pay for them
   Thereby consumers have no incentive to pay for the goods - leads to the “free-rider” problem

Question 4

Define “margional cost”

Answer 4

Cost to society of all the scarce resources used in producing a good, including risk taking for profit

OR

The extra/additional costs associated with a decision to do a little more or a little less of something

Question 5

Define “pareto optimality”

Answer 5

When market is in equilibrium, with no external influences

Question 6

Define “market failure”

Answer 6

Market failure is a situation when the free market under or over allocate good or serviced, which leads to under or over consumption and under or over production

Question 7

Demerit goods

Answer 7

Private good that has negative externalities associated with its consumption

Question 8

Merit goods

Answer 8

Private good that has positive externalities associated with its consumption

Question 9

Define “externality”

Answer 9

An externality refers to a spillover in production or consumption that arises in social costs or benefits from a firm or individual undertaking an economic activity

Question 10

List solutions for Negative Externality of Production

Answer 10

• Taxation
• Fines
• Legislation/Government regulations
• Tradable permits (Allocating Property Rights)

Question 11

List solutions for Positive Externality of Production

Answer 11

• Subsidies or Vocational Training
• Legislation or Government Funding or Decrease Tax
• Advertising to influence behaviour
• Direct provision of goods and services

Question 12

List solutions for Negative Externality of Consumption

Answer 12

• Taxation
• Advertising
• Government regulations/legislation
• Nudges (HL)

Question 13

List solutions for Positive Externality of Consumption

Answer 13

• Subsidies
• Legislation
• Advertising to influence behaviour
• Direct provision of goods and services
• Nudges (HL)

Question 14

How does a government respond to fix market failure?

Answer 14

1. Direct provision - Merit goods, public goods
2. Taxation - Demerit goods, income inequality
3. Subsidizing - Merit goods, help movement of FOP
4. Negative and positive advertising - Information, FOB, merit and demerit goods
5. Extending property rights
6. Legislation

Question 15

Market Failure can arise with…

Question 16

Private goods

Answer 16

rivalrous and exclusive

Question 17

What can a government do to intervene in response to a need for public goods?

Answer 17

From the syllabus:
* direct provision
* contracting out to the private sector

Question 18

common access resources (common pool)

Answer 18

the ‘gifts of nature’ over which there is no private ownership and therefore no effective means of regulating use of the resource

Question 19

Possible solutions for common access resources issues

Answer 19

• privatization
• tradeable permits

Question 20

privatization

Answer 20

assigning private ownership of a resources creates incentives for owners to protect and manage it sustainably

Question 21

tradeable permits

Answer 21

issuing permits to private users to allow limited amount of extraction in a period of time to limit exploitation and maintain sustainable usage.

Question 22

(Asymmetric) information - HL only

Answer 22

decisions are based on incomplete information - either the buyer or the seller (usually the seller) has more information than the other party

Question 23

government solution for asymmetric information

Answer 23

• legislation
• regulation
• provision of information

Question 24

Opportunistic behavior

Answer 24

• this is when one party takes advantage of the fact the other party lacks information
• is results in adverse selection or moral hazard.

Question 25

adverse selection

Answer 25

• results of a decisions when buyers and sellers have access to different information
• it distorts price and quantity

Question 26

moral hazard

Answer 26

when a risk-protected party behaves differently due to more information, imposing costs on less-informed parties or society

Question 27

wealth

Answer 27

the stock of economic goods and services owned and measured at a particular point in time

Question 28

income

Answer 28

the flow of economic payments