Market failure and government intervention Flashcards
When does market failure occur?
When a free market fails to achieve allocative efficiency.
What are externalities?
Spillover effects on third parties arising from production or consumption
Name the causes of information failure
- lack of information, understanding and awareness
- inadequate or misleading information
- persuasive advertisinig
When does information failure occur?
When a lack of information causes consumers and/or producers to make decisions that don’t maximise their welfare
Information failure means that consumers….
over or under estimate the private benefits that the consumption of a good or service would create for them and thus under or over consume it
What is a merit good?
A good that is better for consumers than they realise. (e.g healthcare, education and healthy food)
What are private costs?
Costs paid by the producer for the factors of production needed to produce a good or service
What are external costs?
The costs arriving to third parties as a consequence of negative externalities
What are social costs?
The total cost of production to society ( private costs + external costs)
Possible solutions to information failure
- The provision of information
- State provision
- Regulation (law)
- Taxes and subsidies
What is a positive externality?
A favourable or beneficial effect on a third party
What is a negative externality?
An unfavourable or adverse effect on a third party
What are private benefits?
Benefits that accrue directly to the decision makers
What are external benefits?
The benefits accrued to a third party or society as a whole
What is a de-merit good?
A good that is worse for a person than that person realises
What are the characteristics of private goods?
Excludable and Rival in consumption
What are the characteristics of public goods?
Non-excludable and non-rival
What is a quasi - public good?
Goods which are possessing some but not all of the characteristics of a public good.
What does non-excludability mean?
A consumer cannot be prevented from consuming the good
What does non-rivalry mean?
One consumer’s consumption does not reduce the amount available for consumption by others
What is indirect tax?
A tax placed on producers / retailers of a good or service that can be passed on to the consumers of that good or service
Name some examples of indirect taxation
- VAT
- APD
- excise duties on demerit goods such as tobacco and alcohol
What does the effectiveness of indirect taxation depend on?
- The size of the tax
- The price elasticity of demand
- The extent to which the tax can be avoided
- How the tax revenue is spent
What is a subsidy?
A payment made (usually by a government) to a producer per unit of a good or service that is supplied
Name some examples of subsidies
- payments made to the transport providers in rural areas
What does the effectiveness of a subsidy depend on?
- The size of the subsidy (and hence the increase in supply)
- The price elasticity of demand
- The extent to which a subsidy can be diverted away from the production or consumption of the targeted good
- The opportunity cost of the tax revenue spent on the subsidy
What is information provision?
- Aims to reduce the information failure associated with the consumption of a good or service by increasing or decreasing demand as appropriate
Name some examples of information provision
- information films
- advertising by state-financed bodies such as the NHS
- improvements in product labelling
What does the effectiveness of information provision depend on?
- the nature of the information failure ( e.g no. of people lacking information)
- the nature of the information provision (e.g medium used)
- the receptiveness of consumers and producers to change their views and behaviour ( e.g relatively minor misunderstanding or culturally ingrained belief
- the time available
What is regulation?
- The imposition of laws, standards and controls intended to influence the behaviour of producers and consumers and correct market failure
Arguments for regulation:
- relatively easy and cheap to impose
- sets a clear standard that should be easily understood
- should have an instant effect
- can be backed up by fines and other incentives to comply
Arguments against regulation:
- costly to police and enforce
- difficult to set the right standard
- some producers and consumers may be unaware of the regulation and seek to avoid it
- usually involves no incentive to make positive improvements beyond meeting the regulation
What are tradable permits?
- a market based approach for correcting market failure that involves creating property rights for a particular activity that can then be bought and sold, with the resulting market being manipulated to achieve the desired outcome
What is the most common type of tradable permit?
- Attempting to reduce industrial pollution in the form of carbon emissions (EU’s Emission Trading System (ETS) allocates permits that allow the holder to emit one tonne of carbon
What is state provision?
- occurs where a good or service is supplied by central or local government, usually financed from general taxation and free at the point of consumption
What are some examples of state provision?
merit goods such as: - health care - education public goods such as: - defence - broadcasting
What are the advantages of private sector provision?
- The competition / efficiency argument that suggests greater competition between self-interested profit-maximising producers will lead to increases in quality and lower prices that will benefit consumers
- the moral hazard argument suggests consumers may behave in more desirable ways if they don’t have the safety net of provision to catch them if they suffer private costs
What are the disadvantages of private sector provision?
- consumption depends on an individual’s ability to pay
- some goods and services will be under consumed
- quality may be compromised if prices are driven too low
- regulation may be required to endure free market prices and quantities are acceptable
What are the advantages of state provision?
- consumption is accessible to all irrespective of income
- consumption levels are likely to be higher than for private provision due to the zero price
- regulation of quantity and quality is generally easier
What are the disadvantages of state provision?
- the lack of competition may reduce incentives to improve quality
- free provision may lead to some individuals over-consuming a service at the expense of others
What is a free rider?
- an individual able to enjoy the benefits of consumption without paying for the good or service
