Market Failure 2.8-2.11 Flashcards
What is market failure
a situation in which the free market does not lead to a socially optimal allocation of resources
2 types of market failure
total market failure - free market fails to provide ANY of a good or service
partial market failure - free market fails to allocate scarce resources efficiently
What is economic efficiency?
Occurs in a market when both allocative and productive efficiency are achieved
What is an externality
a spillover effect whereby those not directly involved in taking a decision (third parties) are effected by the actions of others
Private, External + Social costs
P - cost of an activity incurred to an individual (firm or consumer)
E - consequence of externalities borne by third parties
S - total costs to society of a particular action
What is the marginal principle
Economic agents will make decisions based on small (marginal) changes
e.g cost to a firm of producing one more good
Private, External + Social Benefits
P - benefits of an activity to an individual directly taking the economic action
E - benefits received by society as a consequence of externalities from a third party
S - Total benefits to society of a particular action
What is information failure
a lack of information resulting in consumers and producers making decisions that do not maximize welfare
What is asymmetric information?
a situation in which some participants have better information about market conditions than others
What is Moral Hazard?
a situation in which a person who has taken out insurance is prone to taking more risk
What is a merit good?
a good that brings unanticipated benefits to consumers, such that society believes it will be under consumed in a free market
Evaluate the production + consumption of merit goods - FOR
Evaluate the production + consumption of merit goods - AGAINST
What are Demerit goods
their consumption is more harmful than consumers may realize
What is a private good?
Other people can be excluded from consuming it - once consumed it can’t be benefitted from by another person
what are public goods?
goods that are collectively consumed
-in a free market would not be provided as there is no incentive for firms to produce them
features of public goods
non - excludability
non - rivalry
non - rejectabililty
free rider
zero marginal cost
Main Areas of Market Failure
Externalities
Merit and De-merit goods
Information Failure
Public Goods
Lack of Competition
What are taxes
compulsory charges imposed by governments on individuals and firms
2 Types of Indirect Tax
Specific Tax: a tax of a fixed amount imposed on purchases of a commodity
Ad valorem tax: charged as a proportion of the price of a good
Disadvantages of indirect taxation
If PED is inelastic the tax will not have the intended effect on production/ consumption
if tax is too high than lead to unemployment because firm will not want to produce the good
Advantages of using indirect taxation
can internalise negative externalities
can force payment on the polluter
tax revenue can be used to fund merit and public goods
what is a subsidy
a payment usually from the given to the producers or in some cases consumers of goods and services
effect will shift supply to the right
