Market Failure Flashcards
What is social welfare?
Simply, consumer surplus + producer surplus.
What is the socially efficient quantity?
Socially efficient quantity arises when when P = MC. Perfectly competitive markets produce the socially efficient quantity.
What can governments do to try and minimise the effects of market power?
- Use anti-trust policy to try and stop the formation of powerful monopolies. Such policies include:
Sherman Act (1890)
Clayton Act
Celler-Kefauver Act (1950)
Note: When a market is characterised by constantly falling AC curve, governments may choose to allow monopolies, but enforce price regulation!
What is the rationale behind price regulation (used against natural monopolies)?
Governments make sure firms charge no higher than the competitive price. When this happens, quantity in the market increases, and all deadweight loss is eroded. (Draw diagram)
What is the danger with price regulation?
Sometimes governments lack the information required to set the correct price. If the price is set too low, deadweight loss can actually increase, and there is large shortages of goods!
What is a negative externality?
Where costs fall on parties who are not involved in the production or consumption of a good or service. They are effectively caused by a lack of well defined property rights. Example: Pollution - firm dumps pollution into nearby river, leaving nearby residents to pick up the cost!
With reference to internal and external costs, explain the concept of negative externalities?
Assume perf. competitive market.
- A firm’s supply curve is it’s marginal cost (internal costs) of producing a particular good.
- However, a marginal cost of a negative effect (i.e. pollution) to society also exists.
- Socially optimum equilibrium takes into account the internal AND external costs.
- However, if no action is taken by government, firms supply only according to its supply function. RESULT: Too much is produced at too low a cost!
How can governments try and deal with negative externalities?
In effect, governments need to force firms to internalise the externality, shifting the internal costs of production up until it is identical to the social costs of production.
If this is successful, output will reduce and price will be higher, until all the deadweight loss disappears.
What are public goods?
A good that is non-rival, and non-exludable.
Non-rival: The consumption of the good by one person does not exclude others from consuming.
Non-excludable: Once provided, no one can be excluded from consuming the good.
Why do public good cause market failure?
Everyone gets to consume public goods, but few individuals are willing to pay for their provision.
Free rider problem: When individuals rely on other to pay or provide a good.
How do governments deal with the problem of public goods?
They force citizens to pay taxes, and use these to fund public infrastructure projects.
