Market Failure Flashcards
Market failure?
Solution
When price mech/forces of supply & demand fails to allc scarce resources efficiently & society suffers as result
Oft gov intervention
Types of market failure + example? (2)
Complete market failure = no market exists/’missing market’
National defence => gov intervenes/provides
Partial market failure - a market functions but price/quant supplied is wrong
Provision of healthcare if left to market - not all would be able to afford => govs may provide free
Externalities?
Effects that prod/consm’ing a g/s has on third parties (not involved in making/buying/selling/consmp)
Pos/Neg: externalities
External benefits/costs
Examples of externalities
Neg ext? (2)
Pos ext? (2)
Neg/producing steel: pollution
Neg/consmp choc = litter
Pos/prod of milt equp = improved tech
Pos/comsp: training to be doc = benefit to society
Private cost + e.g?
External cost + e.g?
Social cost?
Cost of doing something to consumer/firm
cost to make/buy
Externality
Littler = counci employs to sweet
Ext + priv cost = full cost to society of g/s
Private benefit + e.g?
Ext benefits + e.g?
Social benefit?
Benefit gained by cons/firm
Buying skiing holiday = enjoyment
Externality
Factory investing new equip = need less electr
Priv benefit + ext benefit = full benefit to society
Why does market failure occur
Price mech only takes into account priv costs/benfs not external
Externality diagram - neg externality from prod
pic
MPC:
MSC:
*?
Cost of producing last of unit of good
Marginal private cost + ext cost
Diff between MPC & MSC curves = neg externality/ext cost of prod
When MPC & MSC curves diverge
Example
Ext costs per unit increase with output
Pollution
Pos externality from consumption diagram
pic
When MPB & MPC diverge - example
Vaccination - more vaccinated = greater protc for unvacc
Curves can be seen as:
MPC = supply curve MPB = demand curve
Where are social optimum & equilibrium found :
Why?
S.O/max benf to society: MSC = MSB
Equ: MPC = MPB
Free market = cons/prod’ers only consd priv costs/benfs
Social optimum
Socially optimum level of output/price - mex benefit to society
Negative production externalities =>
Diagram:
Welfare loss?
Overproduction/underpricing
MPB=MPC (non pos ext) but MSC>MSB
Triangle area between MSC & MSB
Positive consumption externalities lead to
Diagram:
Welfare gain?
Underconsumption/underpricing
MSB > MSC
Area between math social cost & benf
Negative consumption externalities lead to
* Can assume
Welfare loss
Overconsumption/overpricing
MPC=MSB
MPB>MSB means that
For each unit of good consumed between Q1/S.O & Qe, MSC>MSB
Area between MSC & MSB
Positive production externalities
Diagram
Welfare gain
Underproduction/overpricing
MSC
Merit good?
Problems (2)
Examples
Greater social benf than private benf = positive consumption externality
Underconsumption - consumers don’t realise full benefits
Underprovided - suppliers only consider private costs/benfs = ignore positive externalities
Health care/education
Demerit goods
Problems (2)
Example
Greater social costs than benefits = neg consumption externalities
Overconsumed - consumers realise harm to themselves
Over provided - suppliers ignore negative externalities
Cigs & heroin = cost of treating diseases
What affects consumption of goods
Individuals may only take short term approach to decision-making = under consumption of merit/over consumption of demerit
Consumers only consider short term benefits/costs ….so…example? Why?
Old age pension
Individuals fail to see need to make provision for changes in future/potential changes in circums
Why are merit goods under- & demerit over- what affects consumption of goods? (4) 2 examples
Only consider short term
Long term private benefits/costs of merit/demerit are better
Short term benefits of pension are less than long term
Short term costs of cigs are less than long term/illness
Imperfect info = under precision of merit goods/over provision of demerit
Effect of imperfect info
2 examples
Demand for merit lower than should be = under provided
Not knowing how serious health problem is = low demand for healthcare/underproduced
Unaware of health problems linked to high alcohol consumption = over consumed
Why do govs intervene
Failure of free market to supply S.O levels of merit/demerit
Types of Gov intervention to correct market failure
Directly provide g/s using taxes/subs to decrease/increase consumption of g/s to socially optimum level
Why is better for gov to correct
Lot of info about costs/benefits of g/s to indvs & society as a whole = can use info to make beneficial decisions
Public good characteristics (2)
Non-excludable = can't stop people from consulting even if they haven't paid Non-rivalrous = 1 person benefitting doesn't stop others from benefitting
Private goods are (3)
Excludable & rivalrous
+ Choice whether to consume private goods
Problem with public goods (2)
Underprovided by market
Non-excludable => free rider problem
Free rider problem
Once provided, impossible to stop someone from benefitting even if they haven’t paid towards
How is market failure for public goods caused
Pg. 50
Free riders = price mechanism won’t work (consumers won’t choose to pay for public good if they can get for free through other consumers)
So no one will provide
+ Difficult to set out price/can’t work out value
Monopoly disadvantages (4)
Restrict consumer choice = less to choose from
Fewer incentives to innovate - don’t have to improve/beat competitors
No incentive to cut costs (no comp = they’re the price makers
Power = exploit suppliers/buyers e.g. demand low price from suppliers/threaten to use another
Monopoly benefits
Can be most efficient way of allocating = 1 producer that’s able to exploit ecos of scale/prod efficiency (unlike lots of small prods)
Profits => research into new prod methods/products => inv & better prods for custs
Large firms = large ecos of scale = low prices + invt companies
Immobile/can’t move FOPs
Example
Land
Labour immobility - geo immobility reasons (5)
Large house prices/rent/cost of living diffs between areas
High costs involved in moving houses
Reluctance to leave fam
Dislike of change
Imperfect info about jobs avb in diff areas
Reasons for occ immobility? (3)
Lack of training/edc/skills to do diff job
Lack of req’d quals/memb’ship (docs register with Gen Med Council)
Lack of workforce
Immobile FOPs ===> Market failure - how
Prob with gov intv?
Immobile FOPs = inefficent use of resources (unused/underused) = inefficency in allocation of resources
Diffc to tackle - Gov can’t move land/force workers to relocate
Improve labour immobility - gov? (4)
2 big factors + specific examples
Could improve geo mobility:
Relocation subsidies/Mortg relief = more affdable for workers
Incentives to encg construction of housing in those areas needing homes for workers
Improve occup mob govs, could provd more training progs to incr skills
Imperfect info
Competitive market?
Should have perfect info = buyers/sellers have full knowledge of prices/costs/benfs/avb of prods
Imperfect info
Symmetric info? Allows? *But?
Perfect info - equally avb to all partcpants
Efficient allocation of resources in/betw markets (assuming rational behaviour)
Rarely exists e.g. buyers dont have time/resources to find full info on prices before buying
Assymetric info
2 examples
Sometimes, assym info caused by:
When 1 has more info than other
Seller can have more info - used car salesman/car history
Buyer can have more info - antiques collector about value
Lack of info caused by unpredictable services e.g. health serv providers
Info failure –> Market failure:
How (4)
Imperfect info = merit underconsumed/demerit overconsumed
Consumers may not know full personal benfs of merit good - might not realise that good edc = better earnings
Lack info to decide which uni course/med treatment is right
How harmful demerit is
Advertising might withhold health dangers for demerit
Info failure - underproviding/overproviding is?
Misallocation of resources & market failure
Why/how does imperfect info affect provision of merit/demerit goods
2 Examples:
Doctors/Pension providers = more knowledge of medicine/pension schemes avb = may persuade client to buy more expv than needed/req’d
Info may be too complex to understand e.g. diff betw computers = don’t know which ones best for needs
Income & Wealth definitions/examples
Income = amount of money received over set period time
Can come from sources/wages/interest on accs/dividends from shares/rents from props
Wealth = value in money of assets held/property/land/money/shares
Some economists argue:
Solution?
Argument?
Inequitable distrbrs of income/wealth is market failure
Redistrb of income/wealth = better allc of resources/incr benf to society
Benefit to poor person from add. £1 income = bigger than loss to rich from paying extra £1 tax
Gov solution to inequality: (2)
Type of solution?
Redistrb income/wealth through taxation = benefit/subsidies to poor/unempl/eld/sick
+ free provision of services helps
= poltc decision based on value judgement
Arguments against restrib of income/wealth?
Reduces incentive for indvs/firms to work hard - needed to encourage efficiency = may lead to greater market failure
How does gov influence supply of certain s-s policies?
Indirect taxes
Types of indirect taxes (2)
Specific taxes = fixed amount charged per unit of partc good
Ad valorem = proportion/% of price
How do indirect taxes affect supply?
Increase cost for producers = supple curve to left
Specific taxes - diagram
Parallel shift
Tax =same regardless of price
Ad valorem tax - diagram?
Non-parallel shift
Bigger impact on higher price goods
What do govs tax more
Sometimes*?
Indirect tax on neg ext goods e.g. petrol/alco
Multiple taxes on 1 item e.g. cigs = excise duty/specific tax + ad valorem on retail price
Aim of high taxes
Internalise externality of good (producer/consumers cover extra cost) = revenue can be used to offset effects of exts
Example of specific tax?
Landfill tax: local auths charged env tax to reflect full social costs = encourages recycling
Tax paid - diagram
Who pays tax
draw graph pg. 59
Amount of tax paid/passed onto consumer…
Depends on PED
Price inelastic = most extra passed onto consumer
Advg to indirect taxes (2)
Cost of neg ext is internalised in price of good = demand down/production = neg ext effect reduced
Even if demand isnt reduced, tax revenue can be used to offset exts e.g cigs/services to help stop smoking
Diasdvgs to indirect taxes (5)
Diffc to put monetary value on “cost” of neg exts
Price inelastic demand = demand noy reduced by extra cost
Usually increases cost of production = reduces int competitiveness
Firms many relocate/sell goods abroad to avoid tax = removes contrbs to eco (tax/employment)
Tax revenue may not be spent on reducing exts
How are buffer stocks used to do
Stabilise commodity prices/unstable price in markets
buffer stocks aim
only work with?
stabilise prices & prevent shortages in supply
storable commodities e.g. wheat
How do buffer stocks work (3)
Max/min price for commodity is set by gov
Price goes below price floor/min = gov buys & stockpiles = demand increases = brings price up
Price above price ceiling/max = gov sells from stockpiles = supply increases = price brought up to acceptable
Buffer stock schemes - diagram
graph
- Do buffer stocks work:
In theory should be suc’ful because selling at max price should pay for purchs at min
Why arent buffer stocks successful (5)
If min price is too high, scheme will spend excessively purchasing stocks/maintain min prices
Good/bad harvests = scheme may buy excessively/run out of stock
Storage/security = expv
Some commodity will deteriorate/waste overtime = losses for scheme
Producers may overprod knowing they’ll get guara min price = massive stockpiles/waste of resources
Gov intervention - state provision is:
Solution to overcome market failure - directly provd some g/s
State provision?
Examples
Use tax revenue to pay for certain g/s = free when consumed + public goods
NHS, state edc, police
How does state provision work: 2 ways
Gov directly provide
Gov purch’s g/s from private sector/proivde for free
e.g. comm health servs from priv. - prov’d free to NHS patients
How can gov failure lead to misallc of resources/example (2)
So effect was:
Local auths charging for waste disposal/DIY waste///attempt to internalise exts of waste disposal
But leads to incr in fly-tipping = neg ext for locals/visual pollution = resources need to be allocated to clear up fly-tipping
Intervention => other unintended neg exts
Market distortions examples (3)
Income taxes = disincentive to working hard - (pay more tax)
Governmental price fixing => surpluses (min prices)
Subsidies = ineffcient - no incentive
gov bureaucracy consequence
lack of investment/prevents eco from operating at full capacity
free healthcare drawbacks (4)
free at point of use = excess demand = waiting lists
waste resources - unused prescriptions
reduce patients’ self-reliance - little things
may not respond to wants/needs of patient e.g. local NHS offcs may relocate just for costs against pop wishes
Subsidies:
Paid to producers by gov
causes of gov failure (2+2)
inadequate info
admv costs
time
‘external shocks’
Result of subsidy:
Diagram:
Price of good falling = qd increases
causes of gov failure - admv costs? (2)
large amounts of resources used = high costs e.g. lrge maintnc costs to offer farmers min price
policing = expv
other causes of gov failure (2)
takes times for govs to work out where there’s market failure + policy = prob may change
external shocks
Disadvgs of subsidies (5)
Diffc to put monetary value on benfs of pos exts
Opp cost = money could be spent on something else
Might make producers inefficient/reliant on subsds - less incentive to inov/reduce costs
Effectivness dpeends on elasticity of demand - inelastic=no sigf increase in demand
Subsidised g/s may not be as good as one being replaced/more expv e.g might be more expv to produce elctrcityy using wind power than fossil fuels
Gov reg aims (3)
Reducing use of demerit goods e.g. by banning/limiting sale
Reducing power of monopoly e.g. price cap
Protection for consms/prods from probs such as asymmetric info e.g. Sale of Goods Act protects consumers against firms supplying substandard goods
How/where should max price be set (2)
*?
Above equ = no impact
Below equ = excess demand/shortage supply (excess demand cant be cleared by market forces = needs to be rationed out/ballot)
Amount of excess demand depends on PES/PED
Minimum price aim
Often set to make sure suppliers get fair price (EU’s CAP/comm agri polc=gu min price for agric prods)
How is max price set **
Below equ = no impact
Above equ = reduces demand/increases supply = excess supply
Gov purchases excess supply to ensure guar min prices = stockpile/destroyed
Amount of excess supply depends on PES/PED
Max price - Gov expenditure - diagram:
graph
Max price advgs: (2)
Increases fairness - allowing more people to purchs certain g/s
Can prevent monopolies from expoliting consumers
Max price disadvgs: (3)
Demand > Supply so not all can buy
Govs may need to introd rationing scheme to allocate e.g. ballot
Excess demand = black market
Min price advgs (2)
Producers = guar min price = encgs investment
Stockpiles can be used when low supply e.g bad weather/overseas aid
Min price disadvgs (4)
Consumers pay higher than equ
Inefficient alloc of reosurces - excess supply resources could be used elsewhere
Gov spending on min price sceme = high opp cost
Destroying excess goods = waste of resc
Gov failure:
Gov intervening => misalloc of resources
3 examples of gov failure
Market distortions
Excsv bureaucracy
Conflicting policy objs
How can gov failure lead to misallc of resources
Local auths charging for waste disposal/DIY waste
Market distortions
Income taxes = disincentive to working hard -
Gov bureaucracy/enforcement
Excessive bureaucracy?
Too many regs slowing down process unreasonably
Gov bureaucracy/enforcement
Excessive bureaucracy?
Red tape interferes with?
Example
Too many regs slowing down process unreasonably = gov failure
Red tape interferes with forces of supply/demand - prevent markets from working
Planning controls => long delays in construction projs - so if delays affect housing devs. supply’s restricted
Time lags so gov cant respond quickly to needs of producers/consms = competitive disadvg (other countries resp quicker)
source of gov failure (2)
conflicting policy objs
gov effort to achieve certain policy obj has neg impacts on another e.g stricter emission controls for ind = helps env objs but increases costs for firms/reduces output (uemp/eco growth)
gov oft favour short term solution - under pressure to solve issues quickly but may increase congestion in long-term
causes of gov failure
inadequate info
diffc to assess extent of market failure = diffc to put value on gov intv needed e.g. may lead to taxes/subsidies being set at an ineffcient level
may not know pop’s wants
causes of gov failure - inadq info?
diffc to assess extent of market failure = diffc to put value on gov intv needed e.g. may lead to taxes/subsidies being set at an ineffcient level
may not know how pop wants resources to be allocated - some may think price mech works better
govs dont know how consmers will react e.g. campgs discging under 18s drinking alcohol = may lead to alchol being viewed as desirable = increases drinking
causes of gov failure - admv costs?
large amounts of resources used = high costs e.g. lrge maintnc costs to offer farmers min price
policing = expv
other causes of gov failure (2)
takes times for govs to work out where there’s market failure + policy = prob may change
external shocks
Gov intervention: gov regulation
Rules enforced by auths to control activities of producers & consumers & try to change undesirable behaviour
Gov reg aims (3)
Reducing use of demerit goods e.g. by banning/limiting sale
Reducing power of monopoly e.g. price cap
Protection for consms/prods from probs such as asymmetric info e.g. Sale of Goods Act protects consumers against firms supplying
Why are regs difficult to set? (5)
Difficult for gov to work out whats ‘correct’ e.g ‘correct’ min age for alcohol - med groups = older & producers might want reduced
Sometimes theres need for reg in some areas to be worldwide rather than 1 country e.g. regs to control greenhouse gas emissions = more effective if w’wide
Following excessive regs = expv so firms can close/move countries
Monitoring = expv
Punishment not harsh enough = waste
Examples of gov reg
Encg of renw energy
Companies reg’d in UK (type)
Privatised utility comps
