Market Failure Flashcards
Market Failure
Market failure occurs whenever a market leads to a misallocation of resources
Misallocation of resources
A misallocation of resources is when resources are not allocated to the best interests of society. There could be more output in the form of goods/services if resources were used in a different way
Welfare
Welfare refers to the overall well-being and quality of life of individuals or society as a whole.
Economic and social welfare cannot be maximised during market failure
Types of Market Failure
- Externalities
- The under-provision of public goods
- Information Gaps
- Monopolies
- Inequalities in the distribution of income
Free Market
where the forces of supply and demand determine prices and resource allocation with minimal/none government intervention
Merit Goods
Merit Goods are products or services that provide benefits to both individuals and society as a whole
Underconsumed in Free Markets
Demerit Goods
Demerit goods are products or services that are considered harmful to individuals and societies.
Often overconsumed in the free market
- Externalities
An externality is the cost/benefit a third-party receives from an economic transaction outside of the market mechanism (spill-over effect of the production or consumption of a good/service).
Negative externalities - Demerit Goods
Positive externalities - Merit Goods
Public Goods
Public goods are products/services that have 2 main characteristics: non-excludability and non-rival
- Non - excludability: means that it’s not possible to prevent people from using the good once it’s provided. For example, once a lighthouse is built, its light is available to all ships passing by, regardless of whether they contributed to its construction.
- Non-rivalry: implies that one person’s consumption of a good doesn’t reduce its availability to others. For instance, someone benefitting from a street light doesn’t diminish the amount of light another person could use.
Private Goods
They are rival and excludable e,g a chocolate bar. Property rights allow it to be yours and can only be consumed by you.
Quasi (non-pure) Goods
They have characteristics of both public and private goods. For example roads, they do sometimes have to be paid through tolls and road tax however consumers can benefit from them whilst other consumers are using it.
Free rider problem
when individuals can benefit from a good/service without paying their fair share of it.
- The under-provision of public goods
Since public goods are non-excludable and non-rival, they would be under-provided due to the free rider problem.
Additionally, it is hard to know the value of public goods so it is hard to put a price on them -> resource misallocation. threat = under-provision.
- Information Gaps
It is assumed that consumers and producers have perfect information when making economic decisions. However, this is rarely the case and this imperfect information leads to a misallocation of resources.
- Monopolies
Since the consumer has very little choice where to buy the good/services offered by a monopoly, they are often overcharged. This leads to under-consumption for a good or service and therefore there is a misallocation of resources, since consumer needs and wants are not fully met.
