Market Failure Flashcards
Define market failure
when the free market fails to allocate scarce resources to maximise social welfare
3 forms of market failure (3)
overallocation - too much is sold/consumed
underallocation - too little is sold/consumed
missing market - public goods
Define an externality (2)
when the production/consumption of good/service has an impact on 3rd party not involved
not market failure, causes market failure
Define negative production externality (2)
production of good/service has negative impact on 3rd party not involved in production/consumption
e.g pollution from factories
Define negative consumption externalities (2)
consumption of good/services has negative impact on 3rd party unrelated
e.g gasoline in cars - pollution, secondhand smoke from cigarettes
Define positive consumption externality (2)
production of good/service has positive impact on 3rd party not involved
e.g car factory - brings jobs + demand for other goods in surrounding areas
Cost of negative externalities
total cost to society > firms cost
Cost of positive externalities (2)
marginal social cost < marginal private costs
firms costs offset by 3rd party benefits
Define merit goods (2)
goods deemed beneficial for consumer/society
generally under-consumed on free markets
Why are merit goods under-consumed on the free market (5)
generate positive externalities which are ignored
consumers unaware of benefits
benefits are unaware of their benefits
benefits felt in longer term and so are discounted
affordability prevent people from being able to consume good
Define demerit goods (2)
goods generally deemed harmful for consumer/society
over-consumed in free market
Indirect taxes to correct negative production externalities (2)
increases producer’s private costs –> shifts the S(MPC) curve inwards towards MSC
ideally per unit tax is = to per unit externality
