Market Failure

Question 0

Define externalities?

Answer 0

The costs or benefits to third parties which are external to an exchange, which are ignored by the price mechanism.

Question 1

Define market failure?

Answer 1

A term that encompasses a situation where, in any given market, the quantity of a product demanded by consumers does not equal the quantity supplied by the producers.

Question 2

What are 2 external costs?

Answer 2

Second hand smoking, pollution

Question 3

Define private costs?

Answer 3

The cost of an activity to an individual economic unit, such as a consumer or a firm.

Question 4

Define social costs?

Answer 4

Private costs + external costs

Question 5

Why do the lines on a diagram showing MSC and MPC diverge?

Answer 5

Because often external costs increase disproportionately with output.

Question 6

When will the MPC and MPS lines be parallel?

Answer 6

When the external costs per unit of output remain constant.

Question 7

What are two external benefits?

Answer 7

Recycling and vaccinations.

Question 8

What are social benefits?

Answer 8

Private benefits + external benefits.

Question 9

What is the vertical gap between the MSC and the MPC called?

Answer 9

External cost.

Question 10

Why do the MSB and MPB lines diverge?

Answer 10

Because often external benefits increase disproportionately with output.

Question 11

What is the vertical gap between the MSB and MPB be called?

Answer 11

The external benefit

Question 12

When is there free market equilibrium?

Answer 12

When the marginal private benefit equals the marginal private cost.

Question 13

When is the social optimum equilibrium is reached?

Answer 13

When the marginal social cost equals the marginal social benefit.

(If the social cost of producing the last unit of output equals the social benefit from consuming it)

Question 14

Why do we want to reach social optimum equilibrium?

Answer 14

Because when it is reached, welfare is maximised.

Question 15

Describe a graph with a welfare lost triangle?

Answer 15

Price on Y axis quantity on X axis. MPC and MSC lines, with an MPB=MSB line too (no external benefits assumed). The welfare loss triangle is above the MPB/MSB, below the MSC and above the MPC.

Question 16

Where would you find a welfare gain triangle?

Answer 16

Above MPB, below MSB and above MSC=MPC

Question 17

What are public goods?

Answer 17

Goods that are non-excludable and non-diminishable/non-rivalry

Examples: public parks, beaches, streetlights

Question 18

What are private goods?

Answer 18

Goods that are excludable and the rivalry/diminishable.

Examples: food, paper, alcohol

Question 19

What are the two problems with public goods?

Answer 19

The free rider problem and the valuation problem.

Question 20

Define a free rider?

Answer 20

A personal organisation which receives benefits the others have paid for without making any contribution themselves.

Question 21

Define a merit good?

Answer 21

A good witches underprovided but the market mechanism.

Question 22

Define a demerit good?

Answer 22

A good which is overprovided by the market mechanism.

Question 23

What is it quasi-public good or non-pure public good?

Answer 23

A good which may not possess perfectly the characteristics of being non excludable but which is non-rival.

Question 24

What is the free rider problem?

Answer 24

Because public goods are non-excludable, free riders will arise, meaning that the price mechanism cannot develop. (the benefits affect everyone but people can refuse to pay)

Question 25

What is the valuation problem?

Answer 25

The reason the price mechanism cannot develop is because consumers will undervalue the public good but producers will overvalue the public good, therefore causing and unclear equilibrium price.

Question 26

What is the principal-agent problem?

Answer 26

A problem that arises when the goals of principles, those standing to gain or lose from the decision, are different from agents those making decisions on behalf of the principal. An example of this is children (principals) and parents (agents). If parents didn’t make their children go to school, the children probably wouldn’t go causing a misallocation of resources due to asymmetric information.

Question 27

Define symmetric information?

Answer 27

Where buyers and sellers have access to the same information.

Question 28

Define asymmetric information?

Answer 28

Where buyers and sellers have different amounts of information. (In insurance issues are often the consumer will have more information than the producer, however in most other cases the producer will have more information than the consumer.)

Question 29

Explain the main problem with the second hand car market?

Answer 29

Producer has better info on the car than the consumer. Therefore the consumer risks paying too much for the car in case it is a ‘lemon’ and they lose out. Due to this fear they don’t buy, and therefore both the consumer and producer may miss out on benefit.

Question 30

What is labour immobility?

Answer 30

When labour is wasted due to work as being in structural unemployment.

Question 31

Describe geographical immobility?

Answer 31

Being unable to get a job due to being stuck in one place, possibly due to family, cost of moving and cost of living elsewhere.

Question 32

How did governments solve the problem of geographical immobility?

Answer 32

Housing subsidies, building council housing, relaxation of planning permission laws so more houses are built.

Question 33

What is occupational immobility?

Answer 33

When workers can’t get jobs due to obstacles such as lack of training, skills and education.

Question 34

How do you governments so occupational immobility?

Answer 34

Providing training schemes increasing the number of people going to further education by giving subsidies.

Question 35

Define a buffer stock scheme?

Answer 35

Scheme whereby an organisation buys and sells on the open market so as to maintain a minimum or maximum price in the market for a product.

Question 36

Define commodity?

Answer 36

A raw material or primary agricultural product.

Question 37

Why do commodities often have unstable prices?

Answer 37

Because they depend on either being found or being grown, both of which are quite unstable factors.

Question 38

Is the demand for primary products likely to be price elastic or price inelastic? Why?

Answer 38

Not many subs - inelastic
Normally necessities - inelastic
Often take up large amount of income- elastic?

Question 39

Is the supply of primary products likely to be price elastic or price elastic? Why?

Answer 39

Stock levels limited - inelastic
Stocks often take long time to be produced so inelastic

Short run - inelastic
Long run - elastic

Question 40

Look

Answer 40

At diagrams:
Page 111
Notes on unstable commodity prices

Question 41

Explain the problem of unstable commodity prices?

Answer 41

The signals are not clear due to the frequently changing prices. The time like between signal and incentive functions and the rationing function means the prices don’t settle quickly so consumers are denied the opportunity to pay stable long-term price.
Therefore produces do not receive a stable income, and therefore there is less incentive to invest in them, therefore causing less likelihood for efficiency and profitability.

Question 42

How does the buffer stock scheme work?

Answer 42

When the price is too low the buffer stock scheme buys its own products causing the demand curve to shift right and therefore the price to increase.

When the price is too high the buffer stock scheme sells the products it bought when the price was too low, causing the supply curve to increase and therefore the price to decrease.

Question 43

How do governments deal with unstable commodity prices?

Answer 43

They impose a minimum price for a product. This stabilises incomes for the producers of supply and elastic products.The problem with this is that it therefore causes a supply surplus. Sometimes this is bought by the government because they created it.