Market Failure Flashcards
Define market failure
Market failure occurs when there is an inefficient allocation of resources in a free market.
How can market failure occur?
- Externalities. A cost or benefit imposed on a third party, leading to under or over-consumption.
- Information asymmetries. Lack of complete knowledge by one party. E.g. people may under-estimate the benefits of education (merit good) or underestimate the costs of smoking (demerit good).
- Monopoly. When a firm has market power and can set higher prices. Monopolies may also be more inefficient because they face less competitive pressures.
- Immobilities. Geographical immobilities occur when it is difficult for people or firms to move to another area. E.g. unemployed coal miners in Yorkshire find it difficult to moveto London because of housing costs. Occupational immobilities occur when it is difficult for people to retrain and get skills in new high-tech industries.
- Public goods .Goods that are non-rival and non-excludable.
- Inequality. Inequality is a type of market failure. For example, due to unemployment, people may have insufficient income to buy goods.
What are the factors of a public good?
•Non-rivalry/non-diminishability. When a good is consumed, it doesn’t reduce the amount available for
others, e.g. street lighting.
•Non-excludability. This occurs when it is not possible to provide a good without it being possible for others to enjoy, e.g. national defence.
•Non-rejectability. With a public good once provided you have no choice but to experience it.
•Zero marginal cost. It costs nothing for more consumers to enjoy it.
•Examples include law and order, national defence,
and street lighting.
However this does encourage the free rider problem where people can enjoy a public good but they may not necessarily pay for it.
What is a quasi public good?
Some goods have part of the characteristics of public
goods, e.g. roads are to an extent non -rivalrous and non-excludable, but not completely.
If too many people use roads, it causes congestion. Some people are not qualified to drive.
What is a pure public good?
A public good with 100% non-rivalry and non-excludability.
What is a private good?
The private good is rivalrous and excludable. If you eat an apple, no one else can eat it. If you walk under a street light, many other people can. That is why a street light is a public good.
What is a social benefit?
- Social benefit is the total benefit to society.
- Social benefit = private benefit + external benefits.
- Social marginal benefit (SMB) = the additional benefit to society of producing an extra unit.
- SMB = PMB (private marginal benefit) + XMB (external marginal benefit)
What is a social cost?
- Social cost is the total cost to society.
- Social cost = private cost + external costs.
- Social marginal cost (SMC) = private marginal cost (PMC) + external marginal cost (XMC)
What is a negative externality?
Negative externality of consumption occurs when a consumer enjoys a good but causes a cost to a third party who was not present in the transaction.
With a negative externality, the social marginal cost is greater than the private marginal cost.
NEGATIVE EXTERNALITY GRAPH
What is a positive externality?
•A positive externality in consumption occurs when there is a benefit to a third party from your consumption.
POSITIVE EXTERNALITY GRAPH
What is a merit good?
A merit good occurs where people may underestimate or be unaware of the benefits of consuming a good. Merit goods often have a positive externality as well.
•Merit goods are under-consumed in a free market.
What is a demerit good?
A demerit good occurs where people under-estimate or ignore the costs of consuming a good.
•Demerit goods often have negative externalities as well (e.g. passive smoking effect to others).
•Demerit goods are over-consumed in a free market.
What is symmetric information?
Symmetric information means both parties share the same knowledge.
What is asymmetric information?
Asymmetric information occurs when one party has more information than other parties.
What is imperfect information?
Imperfect information can occur when all parties lack complete knowledge or awareness, e.g. it is difficult to measure the economic costs of global warming
