Market Failure Flashcards
Define Market Failure
When the price mechanism leads to a misallocation of resources
Name and explain the different types of market failure
(give definitions where necessary)
1.Externalities:
-the external costs/benefits a third party receives from an economic transaction, outside of the market mechanism
-could lead to over/under production/consumption
2.Underprovision of Public goods:
-due to the nature of public goods, there are not profitable to supply in the free market due to the free-rider problem
3.Information Gaps:
-consumers may not fully understand the full benefits/costs when buying products
-Producers may not know the full benefit/costs when producing
–could lead to over/under production/consumption
Name and define the 2 features of public goods
Non-rival: one person’s use of the good doesn’t reduce its availability for others
Non-excludable: you can’t prevent someone from using the good
What is the free-rider problem
When individuals experience the benefit of a good/service without actually paying for it
What is the equation linking
Marginal Private costs
Marginal Social costs
Marginal External costs
Social costs=private cost+ external costs
Go on sketchpad to show negative externalities in production
AND
Positive in Consumption
Did you remember:
1.Inwards shift of MPC to MSC
2.Make sure that MSC is not parallel to MPC
3.Use arrows to show shifts in equilibrium, price and curves
4.Show overproduction/underconsumption
5.Deadweight welfare gain, points to socially optimum equilibrium
6. Point to the socially optimum equilibrium
What asymmetric information
When one party has superior knowledge compared to
another.
Give examples of asymmetric information where:
Seller has more info than buyer
Buyer has more info than seller
(Note: there’s a factor that can apply for both scenarios)
Seller has more info than buyer:
-Second hand market (condition of the product)
-loans/mortgages (hidden fees)
-labour market (true productivity of individual)
Buyer has more info than seller:
-loans/mortgages (ability to repay)
-online marketplaces (knowledge of alternatives)
What is the principal-agent problem
The principal-agent problem arises when there is a conflict of interest between a principal (the person or entity who delegates authority or responsibility) and an agent (the person or entity who is hired or contracted to perform tasks on behalf of the principal).
What is moral hazard
When one party is able to take risks or behave in a way that is detrimental to another party because they do not bear the full consequences of their actions.