Market Failure Flashcards
Define market failure (2)
failure to allocate scarce resources to maximise social welfare in the free market
inefficient allocation of resources
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 actions of producers/consumers has a positive/negative impact on 3rd parties not involved
not market failure, causes market failure
Define marginal private costs (MPC)
costs to producers of producing one more unit of a good
Define marginal social costs (MSC)
costs to society of producing one more unit of a good
Define marginal private benefits (MPB)
benefits to consumers from consuming one more unit of a good
Define marginal social benefits (MSB)
benefits to society from consuming one more unit of a good
Define negative production externality (3)
production of good/service has negative impact on 3rd party not involved in production/consumption
overallocation of resources + more goods produced in relation to social optimum
e.g pollution from factories
Welfare loss of negative production externality
loss of social benefits due to overproduction of good
Policies to correct negative production externalities (4)
Indirect Taxes
Carbon Taxes
Tradeable permits
Government Legislation
Indirect taxes as a way to correct market failure (3)
tax per unit should be = externality per unit
shifts MPC leftward to MSC
lower quantity produced (social optimum) + higher price
Carbon Taxes as a way to correct market failure (2)
tax per unit of carbon emissions
incentivises firms to switch to less-polluting energy sources
Real world examples of carbon taxes correcting externalities (5)
Carbon taxes placed for UK, USA, Australia, etc
businesses opposed to carbon taxes as they raise costs
consumers opposed as they raise prices
Australia - carbon taxes repealed because it was considered to destroy jobs
raises household energy prices –> regressive tax + bad for poor
Tradeable permits as a way to correct market failure (5)
government give each firm a number of permits
permits allow firms to pollute specific amount
can be traded in a market
non-polluting firms = can sell permits + reduce costs
polluting firms = must buy permits + increase costs
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
Welfare loss of negative consumption externalities (3)
MPB > MSB –> overconsumption of good
loss of social benefits from overproduction
correcting externality = society would receive benefit of welfare loss
Advantages of carbon (indirect) taxes (2)
internalise externality - costs previously external are now internal –> paid by consumers + producers
carbon taxes > indirect taxes –> tax resources instead of output so incentivise producers to switch to less-polluting resources
Advantages of tradeable permits (2)
incentivises firms to reduce pollution + switch to more sustainable resources
does not disrupt the market equilibrium
Disadvantages of indirect taxes for correcting market failure (4)
not targeted - difficult to identify the different methods that produce different pollutants
difficult to identify “harmful” pollutants
difficult to identify monetary value of harm done
indirect taxes are regressive –> may disadvantage lower income groups
Disadvantage of tradeable permits for correcting market failure (2)
tradeable permits may be distributed unfairly - potential political favortism
difficult to identify the amount of permits to distribute –> too high = ineffective, too low = permits too costly
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 (4)
generate positive externalities which are ignored
consumers unaware of benefits –> no demand
benefits felt in longer term and so are discounted
affordability prevent people from being able to consume good
Define demerit goods (3)
goods generally deemed harmful for consumer/society
over-consumed in free market
may occur due to consumer ignorance of negative effects
Indirect taxes to correct negative consumption externalities
leftward shift in supply curve so that equilibrium is at social optimum
Real world example of indirect taxes correcting negative consumption externalities (3)
indirect taxes on sugary food + drinks
reduce obesity + health problems caused by sugar
some producers create products with less/no sugar to reduce costs
Indirect taxes as an advantage of negative consumption externalities
increase prices –> incentivise consumers to change their consumption
Indirect taxes as a disadvantage of negative consumption externalities (2)
difficult to measure value of external costs –> hard to identify who specifically is affected
most of these goods have inelastic demand –> more tax revenue required to discourage consumption
Government legislation/regulation as a method to correct negative consumption externalities (2)
prevent/limits consumer activities that cause externalities
shifts MPB towards MSB
Education campaigns as a method to correct negative consumption externalities (2)
persuade consumers to purchase less of goods with negative externalities
e.g discourage consumption of unhealthy goods
Real world examples of education campaigns reducing negative consumption externalities
Advantages of education campaigns as a method to correct negative consumption externalities
simpler
Disadvantages of education campaigns as a method to correct negative consumption externalities (4)
government cost of campaigns use tax funds
not everyone will receive info.
education campaigns are a long term solution
not strong enough incentives
Nudges as a method to correct negative consumption externalities (3)
behavioural economics to encourage consumers to buy less goods with negative externalities
e.g dangers of smoking on cigarette packages
can also be used to encourage desirable behaviour
Disadvantages of Nudges as a method to correct negative consumption externalities (2)
difficult to design effective nudges - not much is known how consumers respond to nudges
may not have same effects across different income/culture groups
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
Examples of government restrictions on production externality situations (3)
issuing liscences/permits for particular activities
banning use of harmful substnaces
prohibiting constiruction in industry/agriculutre portected areas
Real world examples of governments using regulation to reduce externalities (3)
use of sulfoxaflor (pesitiside) was banned due to it being potentially harmful to bees in US
eventually approved for use, excluded crops attractive to bees
allowed use for “emergency” basis
Advantages of government legislation + restriction to solve market failure (2)
easier to implement than market-based policies
force firms to comply + reduce harmful activities
Disadvantagrs of government legislation + regulation to solve market failure (4)
do not incentivise firms to switch to more sustainable FOPs
cannot distinguish between firms with lower or higher costs of reducing pollution
potentially lack technical information - may only be partially effective in reducing externality
costs of supervision lead to opportunity costs
Define collective self-governance (3)
users in community take control of resources + use them sustainably
must have good methods of communication
must be boundaries of the area with the common pool resource
Advantages of collective self-governance (2)
people are able to work cooperatively, ignoring their self-interests
can occur in absence of private ownership of resources + government-owned resources
Disadvantages of common pool resources
boundary of common pool resources is difficult to establish in reality
Characteristics of common pool resources (2)
rivalrous - consumption by one person limits availability for others
non-excludable : not possible to prevent consumers from free-riding
Define the “tragedy of the commons” (3)
users consuming the resource in competition with other users
without considering the sustainability of the good
ultimately depletes it
Define maximum sustainable yield (2)
maximum use of resource
while ensuring that it is sustainable/able to reproduce itself
Education + awareness campaigns as a solution to externalities (2)
consumers may consume less of the product if they are informed of the polluting activities of firms
firms incentivised to use more sustainable resources to stay in competition
Advantages of education/awareness campaigns as a solution to externalities
firms are influenced by their consumers
Disadvantages of education/awareness campaigns as a solution to externalities (2)
may only make a small difference in solving externality
broader environmental issues may not be impacted
International agreements as a solution to externalities (2)
co-operation between gov. can develop tech. to deal with sustainability issues
global common pool resources may require co-operation between gov. bodies
Real world examples of international agreements as solutions to externalities (5)
European Union Emissions Trading System (ETS)
covers energy industry (heat generation, oil, metal)
one permit allows release of 1 tonne of CO2
permits traded in carbon market
succesfully reduced CO2 but does not impact economic performance negatively
Define positive production externalities (3)
production of a good/service has positive impact on 3rd parties
e.g firm developing new technology spreading throughout economy
free market underallocates resources to this good
Direct government provision as a solution to positive production externalities (2)
direct provision of good/service creating positive production externality
e.g provide training for workers, or research + development
Subsidies as a solution to positive production externalities
lowers costs for firms –> increases supply
MPC shifts rightward to MSC
Negatives of subsidies to correct positive consumption externality (2)
not possible to subsidise all goods with positive cons. externality
gov. can make decisions based on political pressure
Government legislation to correct positive consumption externality (2)
enforces consumption of goods with positive externalities
e.g education is compulsory uptill certain age
Education campaigns to correct positive consumption externality (2)
persuade consumers to buy goods with positive externalities
e.g encourage use of sports facilities
Negatives of education campaigns to correct positive consumption externality
difficult to measure externality
Direct government provision to correct positive consumption externality (2)
important goods are provided by governments
e.g healtchare + education
Negatives of direct government provision to correct positive consumption externality (2)
involve the use of gov. funds
cannot directly provide all goods –> must choose (difficult to measure)
Real world of gov. legislation + direct provision solving positive consumption ext. (4)
Bolsa Familia programme
poor families receive cash if they send their children to school + get vaccinated
long-term : increases human capital, short-term : reduces poverty
impact : reduces crime rates
Define a public good (3)
non-rivalrous - consumption by one person does not reduce its availability to others
non-excludable : not possible to exclude someone from using the good
e.g police, national defence, lighthouse
Public goods and market failure (3)
free-rider problem - people can enjoy good without paying (non-excludablity)
no incentive for private firms to provide good
free market fails to produce public goods - no allocation of resources
Define quasi-public goods (3)
non-rivalrous
excludable
e.g fees for museums, toll roads
Government intervention to correct market failure of no provision of public goods (2)
ensure that public goods are provided free of charge (close to)
governments must decide which public goods to produce + how many
Disadvantages of government intervention to provide public goods (2)
difficult for gov. to estimate benefits of public goods –> have no price as not set by free market
gov. susceptible to political pressure
Contracting out the private sector as a way to provide public goods (3)
contract between gov. + private firm
priv. firm carries out task originally done by gov.
e.g gov. contracting construction to private firm to build bridge
Advantages of contracting out the private sector as a way to provide public goods (4)
competition of private firms ensures that most cost-efficient firm can be chosen
provides access to more skills/tech. than the government may have
priv. firm may be more flexible + innovative than gov.
overall –> high quality + low cost
Disadvantages of contracting out the private sector as a way to provide public goods (3)
gov. loses control over goods its attempting to produce
risk of making a poor contract wth company –> higher costs + lower quality
cost of contracting > cost of producing public goods if priv. firms charge high prices
Real world example of governments contracting private firms to provide public goods (2)
US private firms operating prisons under government supervision/ownership to lower costs
2016 U.S Department of Justice report - priv. firms had challenges meeting regulatory standards + ensuring same level of care as gov.
