market failure and government intervention Flashcards
What do private costs determine about the good produced?
- How much of the good should be produced
- The market price of the good
What is the equation for the total social cost?
Social Cost = Private Costs + External Costs
How could you calculate the external costs from a graph?
This is the vertical distance between the Marginal Social Cost (MSC) line and the Margin Private Cost (MPC) line.
Do the MPC and MSC lines move parallel to each other?
No, both lines diverge from each other as external costs increase disproportionately to output.
Define externality.
A cost or benefit to a third-party member outside the market transaction.
Where on a graph is the socially optimal point in a market?
Where MSC = MSB.
What is market failure?
Market failure occurs when the free market fails to allocate resources to the socially optimal level of output.
Describe the difference between public and private goods.
Public goods; non-excludable and non rival
Private goods; excludable and rival
Why are public goods underprovided in a free market?
People who do not pay for the good receive the same benefits from it compared to the ones who do pay. Therefore it is underprovided by the private sector as there is no potential for profit.
Why do governments often intervene in a free market?
Governments usually intervene to correct market failure.
Recall 3 examples of government intervention.
- Regulation
- Indirect taxes
- Subsidies
How do indirect taxes reduce the quantity of demerit goods consumed?
Firms that have to pay the taxes pass them onto consumers in the form of higher prices, thus reducing the quantity demanded.
Define subsidy.
A payment from the government to firms in order to lower their costs of production and encourage them to produce more.
Would the government subsidise alcohol products or education, and why?
Education, because this is a merit good and so subsidising it would encourage learning and improve the quality of the labour force.
Which way would a subsidy shift the supply curve?
To the right (as it reduces the cost of production, which encourage firms to produce more).
