Market failure

Question 1

What is market failure?

Answer 1

Market failure occurs when the market mechanism (price mechanism) fails to allocate resources efficiently, leading to a suboptimal distribution of goods and services. As a result, social welfare is not maximized, and resources are misallocated.

Question 2

What is resource allocation?

Answer 2

Resource allocation is the way in which factors of production (land, labor, capital) are distributed among different uses to produce goods and services. Ideally, resources should be allocated efficiently to maximize social welfare.

Question 3

What is resource misallocation?

Answer 3

Resource misallocation occurs when resources are not used efficiently or are allocated to less beneficial or inefficient uses, leading to productive inefficiency and a failure to maximize social welfare.

Question 4

What are the types of market failure?

Answer 4

The types of market failure include:

1. Inefficiency: Overproduction, underproduction, or waste of goods.
2. Inequity: Unequal distribution of goods and services, leading to social injustice.

Question 5

What is complete market failure?

Answer 5

Complete market failure occurs when a market does not exist at all for a particular good or service. This often happens with public goods like street lighting or clean air.

Question 6

What is partial market failure?

Answer 6

Partial market failure occurs when a market exists but fails to allocate resources efficiently, resulting in overproduction or underproduction of goods and services, often due to externalities or monopolies.

Question 7

What are negative externalities?

Answer 7

Negative externalities occur when costs are imposed on third parties not involved in the transaction, such as pollution from a factory affecting nearby residents.

Question 8

What are positive externalities?

Answer 8

Positive externalities occur when benefits are received by third parties, such as the social benefits of education or vaccination.

Question 9

What are public goods?

Answer 9

Public goods are goods that are non-excludable (cannot exclude people from using them) and non-rivalrous (one person’s use doesn’t reduce the amount available for others), such as street lighting or national defense.

Question 10

What is the free rider problem?

Answer 10

The free rider problem occurs when individuals benefit from a public good without contributing to its cost, typically seen with non-excludable public goods.

Question 11

What is monopoly power?

Answer 11

Monopoly power occurs when a single firm controls the market, leading to higher prices, lower output, and reduced consumer welfare. Monopolies can cause market distortions.

Question 12

What is information failure?

Answer 12

Information failure occurs when one party in a transaction has more or better information than the other, leading to an inefficient allocation of resources, commonly seen in markets like insurance.

Question 13

What is factor immobility?

Answer 13

Factor immobility refers to the inability of factors of production (labor, capital) to move freely between industries or regions, causing inefficiency and economic disparity.

Question 14

What are merit goods?

Answer 14

Merit goods are goods that are under-consumed and provide greater benefits than individuals realize, such as education and healthcare.

Question 15

What are demerit goods?

Answer 15

Demerit goods are goods that are over-consumed and harmful to society, such as cigarettes and alcohol, where individuals may not fully understand the harm they cause.

Question 16

How can governments intervene to correct market failure?

Answer 16

Governments can intervene through regulation, taxation and subsidies, provision of public goods, and price controls to improve efficiency and equity in markets.

Question 17

What are price ceilings?

Answer 17

Price ceilings are maximum prices set by the government to prevent prices from rising too high, typically used to protect consumers, such as rent controls.

Question 18

What are price floors?

Answer 18

Price floors are minimum prices set by the government to prevent prices from falling too low, typically used to protect producers, such as minimum wage laws.

Question 19

What are cap and trade schemes?

Answer 19

Cap and trade schemes are market-based solutions for reducing pollution, where firms are given tradable pollution permits. Firms that pollute less can sell their excess permits

Question 20

What are public-private partnerships?

Answer 20

Public-private partnerships are collaborative arrangements between the government and the private sector to provide goods and services, often in areas like infrastructure or healthcare

Question 21

What is Pareto efficiency?

Answer 21

Pareto efficiency is a situation where no one can be made better off without making someone else worse off. Market failures prevent economies from achieving Pareto efficiency

Question 22

What is the Coase Theorem?

Answer 22

The Coase Theorem suggests that if property rights are well-defined and transaction costs are low, private bargaining can lead to an efficient outcome even in the presence of externalities

Question 23

What is welfare economics?

Answer 23

Welfare economics is the study of social welfare functions, which represent societal preferences and trade-offs between equity and efficiency in resource allocation

Question 24

What is the Tragedy of the Commons?

Answer 24

The Tragedy of the Commons occurs when individuals acting in their own self-interest overuse a common resource, leading to its depletion, such as overfishing or deforestation

Question 25

What is the relationship between market equilibrium and social optimum?

Answer 25

Market equilibrium, where supply equals demand, may not align with the social optimum, especially in the presence of externalities, where market outcomes are not efficient for society

Question 26

What is the conclusion of market failure?

Answer 26

Market failure occurs when the market does not allocate resources efficiently, either due to inefficiency or inequity. Government intervention can correct these failures but must be carefully designed to avoid creating new distortions. Key concepts include externalities, public goods, and monopoly power