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Economics Edexcel A Theme 1 (New Spec) > Market failure > Flashcards

Market failure Flashcards

1
Q

Define market failure

A

When the price mechanism causes an inefficient allocation of resources leading to a net welfare loss

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2
Q

Consequence of market failure

A

Resources are not allocated to their best or optimum use

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3
Q

What are the main types of market failure

A
  • Externalities
  • Under-provision of public goods
  • Information gaps
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4
Q

Define externalities

A

•Costs or benefits which are external to an exchange

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5
Q

What are externalities also known as

A
  • Indirect costs and benefits

* Spillovers from production or consumption from a good/service

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6
Q

Define external costs(negative externalities)

A
  • Negative third-party effects that represent costs outside of the market transaction
  • E.g pollution from coal extraction
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7
Q

Example of external costs in production

A
  • External costs may occur in production and the consumption of a good/service
  • E.g a chemical firm polluting a river with waste
  • This causes an external cost to the fishing and water supply industries
  • Fish catches may be reduced
  • Purification of water may be very expensive to meet the European Commission’s safety standards
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8
Q

Example of external costs in consumption

A
  • Smoking tobacco would pollute the air for others

* The negative third-party effect is passive smoking which may cause non-smokers to suffer the same illnesses

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9
Q

Define private costs

A

Costs internal to a market transaction which are taken into account by the price mechanism

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10
Q

What are private costs of production

A

•Costs internal to the firm which it pays for directly within a free market

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11
Q

Examples of private costs for firms

A
  • Wages for workers •Payment for raw materials
  • Rent of buildings •Machinery costs
  • Electricity/gas costs •Insurance
  • Transport costs
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12
Q

Private costs for consumers

A

•The market price that a consumer pays for a good service

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13
Q

Define social costs

A
  • The sum of external costs and private costs from a market transaction
  • Private costs + external costs = social costs
  • (PC+EC=SC)
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14
Q

What does it mean if the marginal private cost and marginal social cost curves diverge

A
  • External costs increase disproportionately with output
  • (evaluation) However it is possible that external costs per unit of output remain constant
  • In which case the marginal private cost and marginal social cost curves are drawn parallel to each other
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15
Q

Relationship between private cost, external cost and social cost in production of a good diagram

A

(real card 33)

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16
Q

Define external benefits

A

•Positive third-party effects and represent benefits outside of the market transaction

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17
Q

Examples of external benefits in production

A
  • Recycling of waste materials(glass)
  • This reduces the amount of waste disposal for landfill sites and re-using of materials for production
  • This can help to promote sustainable economic growth
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18
Q

Examples of external benefits in consumption

A
  • The vaccination of an individual against various diseases

* Reduces possibility of other people catching a disease who come into contact with the vaccinated individual

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19
Q

Define private benefits

A

Benefits internal to a market transaction which are taken into account by the price mechanism

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20
Q

Consumers and private benefits

A

•In a free market, consumers are only concerned with the private benefits/utility from consuming a good/service

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21
Q

Producers and private benefits

A

The revenue a firm obtains from selling a good or service

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22
Q

Define social benefits

A

•The sum of external benefits and private benefits from a market transaction
•External benefits+Private benefits=Social benefits
(EB+PB=SB)

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23
Q

What does it mean if the marginal private benefit(MPB) and the marginal social benefit(MSB) curves diverge

A
  • The external benefits increase disproportionately with output consumed
  • (evaluation) however it is possible that external benefit per unit consumed will remain constant
  • In this case, MPB and MSB curves would be drawn parallel to each other
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24
Q

Relationship between private benefits, external benefits and social benefits from consuming a good diagram

A

(real card 33)

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25
Q

Production external cost examples

A
  • Burning coal in power stations adding to global warm

* Increased production of biofuels which destroy rain forests + increase food prices

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26
Q

Consumption external cost examples

A
  • Excess alcohol intake could lead to vandalism
  • Expansion of Heathrow airport could lead to road congestion
  • Tobacco smoking which affects passive smokers
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27
Q

Production external benefit examples

A
  • Paper recycling plant reduces waste for landfill sites
  • Construction of the London Crossrail project could increase inward investment and raising local property prices
  • The use of renewable forms of energy to create electricity to emit less carbon emissions than fossil fuels (e.g wind turbines)
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28
Q

Consumption external benefit examples

A
  • Education and training programmes could increase human capital levels
  • Higher labour productivity increases profits for firms
  • Consumption of vaccinations help reduce spread of disease which increase life expectancy for millions
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29
Q

Define market equilibrium

A

Where marginal private benefit equals marginal private cost

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30
Q

What is the supply curve for a firm

A

The marginal private cost curve (MPC)

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31
Q

What forms the market supply curve

A

The addition of all the MPC curves of firms in a market for a particular good or service

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32
Q

What is the demand curve for consumers

A

The marginal private benefit curve (MPB)

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33
Q

What do economists assume about consumer benefits

A

It is possible to measure the benefit obtained from consuming a good by seeing the price which people are prepared to pay for it

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34
Q

Why does the demand curve slope downwards from left to right

A

As an individual consumes more units of a good the marginal benefit falls(marginal utility)

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35
Q

What forms the market demand curve

A

The addition of all the consumers’ MPB curves for a particular good or service

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36
Q

Define social optimum equilibrium level of output

A

Where marginal social benefit equals marginal social cost

•MSB=MSC

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37
Q

What is the social cost of producing the last unit of output equal to

A

The social benefit from consuming it

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38
Q

When is welfare maximised

A

When the social optimum is reached in a market

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39
Q

What market ignores negative externalities

A

The free market

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40
Q

What causes the supply curve of a firm to become the marginal social cost curve

A

Adding external costs on to the production of a good/service, causing the supply curve of the firm shift to the left

41
Q

External costs and the triangle of welfare loss diagram

A

(real card 35)

42
Q

When is the social optimum equilibrium at price OP1 and quantity OQ1

A

When we assume there are no external benefits in the production of a good or service

43
Q

What happens when external costs are ignored

A
  • Underpricing
  • Overproduction
  • Excess of social costs over social benefits for the marginal output between Qe and Q1
44
Q

What is the marginal social cost of the output slice QeQ1

A

QeWYQ1

•This exceeds the marginal social benefit of this output, QeXYQ1

45
Q

What does the triangle XWY show

A

The excess of social costs over social benefits

46
Q

What is the triangle of welfare loss

A

The area of welfare loss to society-the market has failed since negative externalities are ignored

47
Q

What market ignores positive externalities

A

The free market

48
Q

What causes the demand curve to become the marginal social benefit curve

A

Adding external benefits on to the consumption of a good or service causing the demand curve to shift the right

49
Q

When is the social optimum equilibrium at price OP2 and quantity OQ2

A

When we assume there are no external costs in the consumption of the good/service in a free market

50
Q

What happens when external benefits are ignored

A
  • Underpricing
  • Underproduction
  • Excess of social benefits over social costs for the marginal output between Qe and Q2
  • By raising output from OQe to OQ2 welfare could be increased
51
Q

External benefits and triangle of welfare gain diagram

A

(real card 36)

52
Q

What is the marginal social benefit of the output slice QeQ2

A

QeMTQ2 which exceeds the marginal social cost of this output, QeZTQ2

53
Q

What does the triangle MTZ show

A

The excess of social benefits over social costs

54
Q

What is the triangle of welfare gain

A

The area of welfare gain to society-the market has failed since positive externalities are ignored

55
Q

What happens when external costs and benefits are ignored

A

Market failure can be caused

56
Q

Impact of external costs to consumers/producers

1.Overproduction

A

The free market level of output exceeds the social optimum level of output causing overproduction

57
Q

Impact of external costs to consumers/producers

1.Underpricing

A

The free market price is below the social optimum price causing underpricing

58
Q

Impact of external costs to consumers/producers

1.Welfare loss

A

Marginal social costs exceed marginal social benefits causing welfare loss

59
Q

Impact of external costs to consumers/producers

1.Concern over resource availability

A

E.g:
•Overfishing could lead to a collapse in fish stocks which may become unsustainable
•This would create concern over availability of resources

60
Q

Impact of external costs to consumers/producers

1.Concern over pollution levels

A

E.g:
•burning fossil fuels to produce energy could lead to global warming or climate change
•Air pollution could reduce life expectancy
•This would create concerns over pollution levels

61
Q

Impact of external costs to consumers/producers

1.Calls for government intervention

A
  • Government intervention may be needed to internalise external costs
  • This would aid in correcting market failure
  • This may take the form of indirect taxes and trade pollution permits
62
Q

Impact of external benefits to consumers/producers

1.Underproduction (fuugl(y)

A

The free market level of output is less than the social optimum level of output causing underproduction

63
Q

Impact of external benefits to consumers/producers

1.Underpricing

A

The free market price is below the social optimum price causing underpricing

64
Q

Impact of external benefits to consumers/producers

1.Potential welfare gain

A

Marginal social benefits exceed marginal social costs which could lead to potential welfare gain

65
Q

Impact of external benefits to consumers/producers

1.Concerns over long-term implications of underproduction

A

E.g:
•Underprovision of education and healthcare could lead to lower economic growth
•Therefore the economy may lose competitiveness
•Living standards may rise more slowly
•This creates concerns over long-term implications of underproduction

66
Q

Impact of external benefits to consumers/producers

1.Calls for government intervention

A
  • Government intervention may be needed to internalise the external benefits to correct market failure
  • This could be done through regulation, government provision and subsidies
67
Q

What is a missing market

A

When goods are not produced at all through the markets despite offering benefits to society

68
Q

Define public goods

A

Goods that have non-rivalry and non-excludability in their consumption

69
Q

What is collective consumpton

A

Public goods involve a large element of collective consumption
•E.g national defence, flood defence systems

70
Q

What do public goods demonstrate characteristics of

A

Non-excludability and Non-rivalry

71
Q

Define non-excludability

A

Once a good has been produced for the benefit of one person it is impossible to stop others from benefitting

72
Q

Define non-rivalry

A
  • As more people consume a good and enjoy its benefits, it does not reduce the amount available for others
  • So it is non-diminishable
73
Q

What is the cost of supplying a public good to an extra consumer once it has been provided

A

Zero

74
Q

Examples of public goods

A
  • Firework displays
  • Lighthouses
  • Street lighting
75
Q

Define private goods

A

Goods that have rivalry and excludability in their consumption

76
Q

Define excludability

A

Once a good has been produced for the benefit of one person it is possible to stop others from benefitting

77
Q

Define rivalry

A
  • As more people consume a good and enjoy its benefits, it reduces the amount available for others
  • So it is diminishable
78
Q

Example of private goods

A
  • A chocolate bar

* The consumption of the good directly excludes other people from consuming that particular good

79
Q

How can owners of private goods prevent other people from consuming them

A

By using private property rights

80
Q

What does it mean if private goods can be rejected

A

One has a choice over whether to consume them or not

81
Q

Why are public goods underprovided in a free market

A

Due to the free rider problem

82
Q

Why does the market fail due to the free-rider problem

A
  • Once a public good has been provided for one individual it is automatically provided for all
  • It is not possible for firms to withhold the good from consumers who refuse to pay for i
  • This causes market failure
83
Q

Examples of public goods that contribute to the free-rider problem

A

National defence and street pavement

84
Q

What would a rational consumer do in terms of the free-rider problem

A

They would wait for someone else to provide the good and then obtain the rewards by consuming it for free

85
Q

Disadvantages of the free-rider problem

A
  • If everyone waits for others to supply a public good then it may never be provided
  • The non-excludability part means that the price mechanism can’t develop as free-riders won’t pay
  • Firms are reluctant to supply this type of good in a free market as it would be difficult to gain profits
86
Q

Government solutions to the free-rider problem

A

The government would provide public goods and fund them from general taxation

87
Q

Define information gaps

A

Where consumers, producers or the government have insufficient knowledge to make rational decisions

88
Q

How do information gaps lead to market failure

1.Unequal balance of information

A
  • Consumers or producers may have more market knowledge than the other about a good or service
  • So there is an unequal balance of information when carrying out economic transactions between them
  • This causes market failure
89
Q

How do information gaps lead to market failure

2.Non-rational decisions

A
  • Consumers or producers may lack perfect knowledge about a good or service
  • This causes them to make non-rational decisions
90
Q

Define symmetric information

A

Where consumers and producers have access to the same information about a good or service in a market

91
Q

What is assumed about symmetric information

A
  • It is assumed that consumers and producers have symmetric information when making decisions
  • So they have access to the same information about a good or service in a market
92
Q

How does symmetric information lead to an efficient allocation of resources

A
  • Consumers and producers would be assumed to act rationally
  • This would lead to an efficient allocation of resources
  • Consumers would buy a good/service from a producer offering the best deal
93
Q

Define asymmetric information

A

Where consumers and producers have unequal access to information about a good/service in a market

94
Q

How does asymmetric information lead to an inefficient allocation of resources

A
  • Consumers and producers would have unequal market knowledge
  • This would lead to irrational economic decisions
  • This would cause a misallocation of resources
95
Q

Define lemon market

A

When the market price for all goods are reduced and the losers are both buyers and sellers

96
Q

Solutions to imperfect knowledge and a misallocation of resources (when producers have more knowledge)

A
  • Inspection schemes by motor organisations for cars
  • Watchdog bodies to investigate offending practitioners who over-treat patients for higher profits
  • Producer knowledge may exceed consumer knowledge
  • E.g a car salesman may have more knowledge of the goods than consumers
97
Q

How can imperfect knowledge lead to a misallocation of resources (when consumers have more knowledge)

A
  • Consumer knowledge may exceed producer knowledge
  • E.g a consumer may purchase an insurance company that hides important details (e.g risky lifestyle)
  • The insurance company may insure someone who is too risky to insure causing a loss
98
Q

What does imperfect knowledge mean

A
  • Many people fail to make sufficient contributions to pension schemes (schemes providing income to people when they retire from work)
  • This reflects the uncertainty surrounding their long-term future circumstances(quality of health)
  • There is also the risk with the type of pension scheme as returns are linked to performance of the stock market
  • This may lead to little provision for retirement and people ending up in poverty in old age
99
Q

Solutions to imperfect knowledge and a misallocation of resources (when consumers have more knowledge)

A
  • Watchdog bodies with powers to investigate and prosecute fraudulent insurance claims (for insurance)
  • Government intervention to make it compulsory for owners to contribute to a National Insurance scheme
  • This allows payments for state pensions(for pensions)

Economics Edexcel A Theme 1 (New Spec) (5 decks)

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