market failure Flashcards
what is market failure?
market failure occurs when there’s an inefficient allocation of resources in a free market.
what is allocative efficiency?
Allocative efficiency occurs when price = marginal cost.
what is partial market failure?
Partial market failure occurs when the market functions/exists, but it
supplies the wrong quantity of a product.
what is complete market failure?
Complete market failure occurs when the market does not supply products at all – there is a missing market.
what are production externalities?
the impact on 3rd parties of production decisions.
what does internalising the externality mean?
when the decision marker takes into account 3rd party impacts.
how can externalities be solved?
taxes, bans, regulations, education and tradable pollution permits.
how can taxes solve externalities?
look at tax digram
e.g. sugar tax, road tax, excise duties, environmental taxes.
They can be used to raise the price of products with negative externalities which raises the opportunity cost of consumption. it aims to internalise the negative externality by making the decision maker bare the cost of the externality.
what are the limitations of implementing taxes to fix market failure?
- its very hard to put a value of the amount of tax needed
- if tax levels are too high production levels are too low whereas if tax isn’t high enough over production occurs and the external costs are not made up for.
- costs of taxes - costs of administration (must be less than the social costs), tax evasion, inequality
how can bans solve externalities and what is the limitation?
they are a form of regulations for products to remove their negative externality.
they may result in a black market (where you can’t control the quality or employee rights and exploitation.
how can regulations be used to solve externalities?
the government imposes requirements on private firms and individuals to achieve the governments purpose by increasing the costs of production.
e.g. health and safety standards in workplaces, child labour laws, education laws.
- however the government needs to enforce them which carries an additional cost.
how do tradable pollution permits solve externalities?
the government provides a fixed number of permits so levels of pollution are at the social optimum so firms have the legal right to pollute up to a certain limit.
(their supply is perfectly inelastic because there is a fixed quantity of permits and the market cannot produce more if demand increases)
what are the limitations of tradable pollution permits?
- the disincentives to produce is not large/severe enough
- richer firms can buy permits from poorer counterparts.
- its hard to measure how many permits to give out.
administrative costs.
what are the characteristics of a private good?
- Excludable (buyers can be excluded from benefiting from the good if they are not willing or able to pay for it)
- Rival (one person’s consumption of a product reduces the amount left for others to consume and benefit from)
what are the characteristics of public goods?
- Non-excludable (once a good is provided it is impossible to prevent
people from using and benefiting from it; non-payers can enjoy the
benefits for free creating a ‘free rider’ problem.) - Non-rival (consumption of a good by one person does not prevent or reduce the benefits to another person consuming the good.)
why does the free rider problem occur?
because public goods are non-excludable its difficult to charge people for benefitting once a product is available.
what is a pure public good?
non-excludable and non-rival all of the time, e.g. national defence, security, mass vaccination.
what is a quasi public good?
a near public good, with some characteristics of a public good.
- semi non rival (up to a point, more consumers using a park or a road do not reduce the space available for others.
- semi non excludable (its possible but difficult or costly to exclude non paying customer such as fencing park.
what is a merit good?
goods and services the government feels people will under-consume and which might be subsidised or made free at the point of use.
- merit goods can be rival, excludable and rejectable
- consumption generates positive externalities (the social benefit exceeds the private benefit)
they are goods that society values and judges that purple should have regardless of their ability to pay
e.g. education, healthcare, public transport
how can merit goods cause market failure?
The free-market equilibrium for merit goods is under consumed as consumers fail to consider the external or private benefits from consumption
The quantity consumed is below the socially optimal level resulting in an under-consumption and a partial market failure. There is a deadweight loss to society.
To be socially efficient, more factors of production should be allocated to producing this good/service
what are de-merit goods?
category of goods that are believed to have a negative externality that are not fully recognised by individuals consuming the good.
- so their consumption has a spill over effect on society.
e.g. tobacco, alcohol, junk food, gambling.
how do de-merit goods cause Market failure?
in the absence of government intervention, individuals may over-consume these goods leading to adverse effects on society because they fail to take into account external costs.
The quantity consumed is above the socially optimal level, resulting in overconsumption and a partial market failure. There is a deadweight loss to society
To be socially efficient, fewer factors of production should be allocated to producing this good/service
what is imperfect information?
occurs when individuals have inaccurate, incomplete or uncertain knowledge to make an informed decision.
- it can lead to the over or under consumption of a good or service
what is a market share?
the % of customers compared to the entire market.
what are the problems with monopolies?
- prices are higher (they are less likely to be efficient with resources)
- no incentive to improve quality due to lack of competition.
under what conditions doo monopolies exist?
- there are no substitutes
- strong barrier to entry
- one seller and lots of buyers
how do monopolies cause market failure?
Firms with monopoly power can set prices well above marginal and average cost and achieve high supernormal profits.
Higher prices can lead to a deadweight loss of economic welfare because it restricts output and can also lead to an increase in inequality.
what is factor immobility?
scarce resources cannot easily be moved from one use to another.
what is the definition of unemployment?
individuals who are willing and able to work at the going wage rate but cannot find a job.
what is geographical immobility?
when workers are unable to move to get a job.
what is occupational immobility?
the inability of labour to switch between different occupations, skills aren’t transferable.
what policies can be used to overcome factor immobility?
- training and education
- support access to housing
- make it easier for firms to operate in certain areas
why is factor immobility market failure?
unemployment is a waste of scarce resources - inefficient
- all resources are needed to contribute to solving the economic problem.
what is absolute poverty?
severe deprivation
- doesn’t really occur in the UK
what is relative poverty?
50/60% of the median household income.
what is the poverty trap?
factors which prevent generations from getting out of poverty
what is the wealth gap?
the difference between the most wealthy and the east wealthy in an economy.
what policies can be implemented to overcome poverty and inequality in resource allocation?
- national minimum wage
- living wage
- universal credit
- childcare tax credit
- social security
- marginal/progressive tax rate
how does poverty and inequality represent market failure?
it shows underconsumption:
- If a large proportion of the population has a low income, they will be unable to afford to consume goods and services at the level that maximises social welfare.
- This can lead to a lack of demand and underproduction of certain goods and services, leading to allocative inefficiency.
