Market failure and externalities Flashcards
What is the acronym for the function of prices
RISA
What are the 4 functions of prices rising
- Ration resources by decreasing consumption
- Incentivise firms to increase output to maximise profit
- Signal excess demand and need for more resources
- Allocate resources efficiently
What are the 4 functions of prices falling
- Ration resources by increasing consumption
- Incentivise firms to decrease output to maximise profit
- Signal excess supply and need for less resources
- Allocate resources efficiently
What are the two characteristics of pure public goods?
- Non excludable
- Non rival
What is non excludability (public good)?
No price can be charged for the good (does not exclude anyone)
What are the two reasons why no price can be charged for a pure public good?
-The benefits of consuming the good cannot be confined to the individual which has paid
- There is no cost efficient way to price it (may be too expensive)
What is non rival (public goods)
- The quantity of the good doesn’t diminish upon consumption
Explain the free rider market failure with pure public goods
Where individuals have the incentive not to contribute anything to the provision of public goods and wait for others contributions and ‘free ride’
What is the the characteristics of pure public goods which allows the free rider issue to occur?
Pure public goods are non excludable and non rival
What could the free rider issue with pure public goods lead to if everyone in the market chooses to free ride?
May lead to a missing market
What is a Quasi public good?
It is a public good which may display the characteristics of a private good ( be excludable and rivalry )
Give an example of a Quasi public good
Roads
Excludable - (Congestion charge, tolls)
Rivalry - (Rush hour, consumption diminishes availability)
What is a merit good?
Goods which are deemed to be more beneficial to consumers than they realise, which generate positive externalities in consumption
Why can merit goods lead to market failure?
They are under produced and under consumed
What is the reason why merit goods are under produced and under consumed?
Imperfect information
What are 2 reasons for imperfect information
Information failure
Asymmetric information
What is information failure?
Information not present, clear or consumers choose to ignore
What is asymmetric information?
Information exists but is not shared equally between two parties
Give 3 examples of a merit good
Healthcare
Education
Exercise
Draw the diagram for merit goods
What is a demerit good?
A good which is deemed more harmful to consumers that they realise which generate negative externalities in consumption
Why do demerit goods lead to market failure?
They are overproduced and overconsumed
Why are demerit goods overproduced and overconsumed?
Due to imperfect information
Give 3 examples of demerit goods
Cigarettes, alcohol, gambling
Draw the diagram for demerit goods
What is a positive externality?
Benefit to third parties as a result of the actions of a separate agent
What is a positive externality in consumption?
Benefits to third parties as a result of the actions of consumers
What is the relationship between social benefit and private benefit for positive externalities in consumption ?
MSB > MPB
Draw the diagram for positive externalities in consumption
Give an example of a good or service which generates positive externalities in consumption
Education
What is a positive externality in production?
A benefit to third parties as a result of the actions of producers
Give an example of a positive externality in production
Training, R and D
What is the relationship between social cost and private cost for positive externalities in production?
MPC > MSC
Draw the diagram for positive externalities in production
Why are resources allocated at the private optimum and not the social optimum for goods which generate externalities in production
Producers act within their own self interest
Why are resources allocated at the private optimum and not the social optimum for goods which generate externalities in consumption
Consumers act within their own self interest
What are negative externalities?
Costs on third parties as a result of the actions of a separate agent
What is a negative externality in production
Cost to third parties as a result of the actions of producers
Give 2 examples of negative externalities in production
Air pollution (From factory work)
Resource depletion (From mining)
What is the relationship between social cost and private cost for negative externalities in production
MSC > MPC
Draw the diagram for negative externalities in production
What do negative externalities in production lead to
Over production/consumption
Misallocation of resources
What is a negative externality in consumption
Cost to third parties as a result of the actions of consumers
Give 2 examples of goods which generate negative externalities in consumption
Smoking
Alcohol
What is the relationship between social benefit and private benefit for negative externalities in consumption
MPB > MSB
What do MSB and MPB represent diagrammatically
Demand
What do MSC and MPC represent diagrammatically
Supply
Are goods which generate positive externalities over or under consumed/produced ?
Under consumed/ produced
Are goods which generate negative externalities over or under consumed/produced ?
Over consumed/produced
Draw the diagram to show how a subsidy can be used to solve positive externality in consumption market failure
Draw the diagram to show how indirect taxation can be used to solve negative externality in consumption market failure
Draw the diagram to show how indirect taxation can be used to solve negative externality in production market failure
Draw the diagram to show how a subsidy can be used to solve positive externality in production market failure
What can be used to help solve positive externality market failure
Subsidies
What can be used to help solve negative externality market failure
Taxation
What is regulation in order to solve market failure?
It is a rule or law enacted by the government that must be followed by economic agents to encourage a change in behaviour
What type of approach is legislation/regulation to solve market failure
Non - market based aproach
Give one benefit of using legislation to solve market failure compared to a subsidy or tax?
It doesn’t depend on the elasticity of the good or service
Give examples of commands within regulation to solve market failure
Bans
Age limits
Compulsories
Caps (maximum number available to purchase for example)
What are the two factors which make up regulation
Command and control
Give the two examples of controls within regulation to solve market failure
Enforcements
Punishment
What is the purpose of solving market failure?
To get to the socially optimum level of output and price (achieve allocative efficiency)
Give 4 negatives of using regulation to solve market failure
Costly
Difficult to set the correct regulations (too strict or too loose)
Black markets arise
Risk of government failure
Draw the tax incidence diagram
What is government failure
When the costs of government intervention within a market outweigh the benefits
What is the result of government failure
A worsening of the allocation of scarce resources
What are the 4 causes for government failure
Information failure
Admin & enforcement costs too high
Regulatory capture
Unintended consequences
What is information failure which leads to government failure
Policymakers not having full information especially when it comes to valuing externalities
Give 3 examples of policies which fall under high admin and enforcement costs as a cause of government failure
Regulation
Subsidies
State provision
Give examples of unintended consequences which lead to government failure
Black markets arising
Impact on the poor (Tax)
Firms dependent on subsidies
What is regulatory capture
When the interests of society are overlooked for the interest of CEOs and managers
When can regulatory capture occur
When regulating monopoly power
(Monopolies good for CEOs and bosses but not for consumers)
What is the law of unintended consequences
Actions of people, especially of government, always have effects that are unanticipated or unintended.
Explain the idea of tragedy of the commons
The tragedy of the commons is a concept which states that if many people enjoy unrestrained access to a finite, valuable resource, such as a pasture, they will tend to overuse or exploit it and may end up destroying its value altogether.
