Market Failure Flashcards
What determines the most efficient allocation of scarce resources in a free market?
The price mechanism
Scarce resources include factors of production such as land, labour, capital, and enterprise.
What is Market Failure?
A less than optimum allocation of resources from the point of view of society.
What are demerit goods?
Goods/services that are harmful and often result in over-provision and over-allocation of resources, e.g. cigarettes.
What are public goods and merit goods?
Goods/services that are beneficial and often result in under-provision and under-allocation of resources, e.g. schools.
What is one consequence of market failure related to equity?
Inequality where the rich get richer and the poor get relatively poorer.
What environmental issue can arise from market activities?
Environmental damage during the production or consumption of a good/service.
What are externalities?
External impacts on a third party not involved in the economic transaction between the buyer and seller.
What is the difference between private costs and external costs?
Private costs are what is actually paid, while external costs are damages not factored into the market transaction.
What is the formula for social cost?
Social cost = private cost + external cost.
What are external benefits?
When the social benefits of an economic transaction are greater than the private benefits.
What is the formula for social benefit?
Social benefit = private benefit + external benefit.
What results from market failure in terms of goods consumption?
Overconsumption of demerit goods and goods with external costs, and underconsumption of merit goods and goods with external benefits.
What are four commonly used methods to address market failure?
- Indirect taxation
- Subsidies
- Maximum prices
- Minimum prices
What is a maximum price?
A price set by the government below the existing free market equilibrium price.
What is one advantage of using maximum prices?
Some consumers benefit as they purchase at lower prices.
What is a disadvantage of maximum prices?
It distorts the allocation of resources in markets, often resulting in excess supply.
What is a potential issue with subsidies?
They are prone to political pressure and lobbying by powerful business interests.
