Market Failure Flashcards
How is allocative efficiency achieved?
Allocative efficiency is achieved when society produces and consumes the optimal mix of goods and services that maximise its welfare. It is achieved where MSB=MSC.
How is equity achieved?
Equity occurs when there is fairness in the distribution of essential goods and services.
Define market failure.
Market failure occurs when the free market is unable to allocate resources efficiently.
What are the characteristics of a public good?
Non rivalry, non excludability, non rejectability
How does the non excludability of public goods lead to market failure?
(Define non excludability) Since those who cannot pay will not be excluded, no one has the incentive to pay for the good. This leads to free-rider problem where everyone will wait for someone else to pay, in hopes of enjoying the marginal benefit from the good without having to pay for it. In such case, there will be no effective demand for the good. Since there is no effective demand for the good in the market, firms will make the rational decision not to enter the market to supply the good. Therefore, if the provision of public goods were left to private firms, there would be no resources allocated to the production of such goods.
Define externalities.
An externality is the spillover cost or benefit borne by third parties due to the consumption or production of a good or service.
Define factor immobility.
Factor immobility refers to the inability of factors of production to move freely.
Define information failure.
Information failure occurs when one of the economic agents lack critical information to make rational decisions on choices and resource allocation.
Define asymmetric information.
Asymmetric information refers to a situation when one party in the economic transaction has more information than the other party. The party involved do not have the same amount of knowledge resulting in a distortion of incentives and inefficient market outcomes.
Define adverse selection.
Adverse selection is when certain parties naturally select themselves out of the market. This leads to a missing market as these parties cannot buy or sell good even if it is beneficial for them to do so.
Define moral hazard.
Moral hazard refers to a situation where an economic agent behaves in a way that is detrimental to society as the agent does not fully enjoy the benefits or bear the costs of their actions
Define occupational immobility.
Occupational immobility is often due to the mismatch between the skills of factors of production and those required by the producers seeking factors of production. Resulting in the inability for the FOPs to move from one sector/occupation to another.
