Market Failure and Government Intervention Flashcards
What are the assumptions of the free market?
- private good
- no externalities
- perfectly competitive market (perfect information, perfect factor mobility, absence of market dominance)
Explain why allocative efficiency may be achieved in a free market
R1 and R2
R1: How price mechanism in the free market could achieve market EQ (signalling/rationing/incentivising role + why are other points are not market EQ)
R2: Explain how the market EQ may be allocative efficient (assumptions that hold? Any other output level results in MSB ≠ MSC)
2 graphs: one for R1 and one for R2
What are some reasons for market failure
causes + definition (5 in total)
- Externalities: consumption/production generates external benefit/cost to third party not involved in consumption
- consumer ignorance: consumers lack perfect information about the true benefit/cost of consumption
- public goods: non-excludable, non-rivalrous, non-rejectable
- asymmetric information: one party knows more than the other (seller/buyer)
- factor immobility: FOPs are not suited to produce all kinds of goods (occupational immobility or geographical immobility)
What are the impacts of the different reasons for market failure?
- externalities: Consumers disregard external benefits/costs and make decisions only based on MPB/MPC
- consumer ignorance: consumers base their demand on their perceived MPB, which is different from true MPB
- public goods: non-excludability results in no production of the good, non-rivalry means that MB = MC cannot be achieved
- asymmetric information: adverse selection, moral hazard, supplier-induced demand
- factor immobility: FOPs cannot switch from a declining sector to a growing sector (leads to unemployment) and cannot meet the rising demand for the growing sector
Flow of market failure questions
- define the problem
- illustrate with examples/context
- diagram
- free market outcome
- socially optimal outcome
- welfare loss
Policies
8 in total
- indirect taxes
- subsidies
- tradable permits
- grants/vouchers
- direct provision
- total ban
- quota
- public education
This is particular to pollution
policies to tackle negative externality
policies+ effect (6 in total)
- indirect taxes (per unit of output): raises MCOP, SS decrease, fewer units consumed/produced as price rises
- pollution tax(tax per unit of pollution): reduce MEC as firms are incentivised to use cleaner means of production to avoid paying pollution tax
- tradable permits (government decided on total allowable pollution, issues corresponding permits): reduces MEC as firms with lower clean up costs would be incentivised to use cleaner methods of production to avoid buying more permits or they could sell their permit
- total ban: quantity consumed to zero
- regulation (controls): Reduces MEC to comply with regulations (partial ban)
- developing alternatives: reduce MEC with methods of cleaner production
policies to tackle positive externality
policies + effects (4 in total)
- production subsidy (per unit of output): reduces MCOP, SS increase, more units consumed/produced as price falls
- grants: increases demand as buyers purchasing power increases
- Free provision (direct vs indirect): price reduced to zero, Qd increases
- regulation (compulsory consumption): increase demand/quantity consume
policies to tackle consumer ignorance
policy + effect (1 only)
- public education: shifts percieved MPB as consumers gain information and quantity consumed will rise/fall accordingly
only public education targets root cause
policies to tackle public goods
policy + effect (1 only)
- free provision: government decides on the quantity to produce, and provides it to consumers for free (funded by tax revenue)
no other policies as there is no effective demand for public goods
