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Economics SL (Year 2) - IB > Market Failure and Market Analysis > Flashcards

Market Failure and Market Analysis Flashcards

1
Q

Market Failure Definition A

A

Occurs when competitive outcome of free markets is not efficient for the whole economy

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2
Q

Causes of Market Failure [A]

A
  • Externalities causing private and social costs and/or benefits to diverge
  • Lack of pure public goods/merit goods
  • Common Access Resources & threat to sustainability
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3
Q

Causes of Market Failure [B]

A
  • Factor immobility
  • Government policy failure
  • Inequity – income distribution (fairness) issues.
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4
Q

Externalities

A

Incidental costs or benefits to a third party not involved in an economic activity

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5
Q

Determination of Externalities

A

Determined when a transaction occurring in a market doesn’t yield socially optimal (or allocatively efficient) outcomes

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6
Q

Total Social Cost

A

Marginal cost (supply) of providing the last unit sold

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7
Q

Total Social Benefit

A

Marginal benefit (demand) of purchasing the last unit brought

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8
Q

Marginal Social Benefit Calculation

A

Marginal Social Benefit = Marginal Private Benefit (MPC) + Marginal External Benefit (MEC)

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9
Q

Marginal Social Cost Calculation

A

Marginal Social Cost = Marginal Private Cost + Marginal External Cost (MEC)

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10
Q

Allocative Efficiency

A

Occurs when firms produce goods and services most valued by society

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11
Q

Efficient Allocation of Resources

A

Scarce resources are allocated so that consumer and producer wants and needs are met effectively

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12
Q

Free Market Equilibrium

A

A free market produces at Qprv, where MPC = MPB

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13
Q

Determining Allocative Effeciency

A

Involves comparing the cost of producing an extra unit (marginal cost) with the benefit gained from its consumption (marginal benefit).

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14
Q

Optimal Equilibrium

A

The market equilibrium where MSC = MSB at Q(Opt) and P(Opt)

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15
Q

MSC > MPC

A

Negative externality in production

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16
Q

MPB > MSB

A

Negative externality in consumption

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17
Q

MSB > MPB

A

Positive externality in consumption

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18
Q

MPC > MSC

A

Positive externality in production

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19
Q

Chart Type: MSC > MPC

A
  • MSC is upleft of MPC
  • Welfare loss triangle facing right between MSC and MPC
  • Marginal external cost between MSC and MPC
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20
Q

Chart Type: MPB > MSB

A
  • MPB is upright of MSB
  • Welfare loss triangle facing right between MSB and MPB
  • Marginal external cost between MSB and MPB
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21
Q

Chart Type: MPC > MSC

A
  • MSC is downright of MPC
  • Welfare gain triangle facing left between MPC and MSC
  • Marginal external benefit between MPC and MSC
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22
Q

Chart Type: MSB > MPB

A
  • MPB is down left of MSB
  • Welfare gain triangle facing left between MPB and MSB
  • Marginal external benefit between MPB and MSB
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23
Q

Supply/Demand Label: Component of Market Failure

A

Assume S = MPC or D = MPB at the start of your market failure analysis (if they make up the component of market failure)

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24
Q

Supply/Demand Label: Not a Component of Market Failure

A

Assume S = MSC or D = MSB if they’re not part of the market failure being discussed

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25
MC of an extra unit < MB of consumption
Optimal to increase production from underproduction (and use additional resources for the better use)
26
MC of an extra unit > MB of consumption
Optimal to decrease production from overproduction (and release resources for better uses)
27
Positive Externalities and Optimal Production
- Private optimal amount to produce < socially optimal amount - Loss in net benefit from underproduction
28
Solution to externality: internalizing the externality
Make the private cost/benefit equal the social cost/benefit of an economic activity
29
Issue with internalizing the externality
Can be difficult to calculate & prioritize costs vs. benefits of an activity, particularly externalities
30
Job Security and Externalities
Must weigh job security when reducing an externality means reducing the revenue of a firm
31
Subsidies
- Subsidize firm’s costs of producing good - Will shift MPC curve to the right towards the MSC curve
32
Issues with Subsidies
Create taxpayer burden & appeals from non-subsidized firms
33
Indirect Tax
- Shifting MPC leftwards to correct for a negative production-based externality - Useful when government knows how much to shift MPC
34
Issues of Indirect Tax
Optimal degree to shift MPC can be difficult to determine
35
Legislation
- Governments can ban/limit consumption/use of certain goods - Creates enforcement costs and potential black market activities
36
Advertising & Persuasion Goal
Bring equilibrium price & quantity closer to social optimum, where MSB = MSC
37
Advertising & Persuasion (discouraging)
- Government dissuades consumers from product via PSAs - Ex: cigarette ads, drinking and driving - Opportunity costs of producing, distributing PSAs
38
Advertising & Persuasion (encouraging)
- Government advertises benefits of using product/service - Ex: Advertising to promote flu vaccinations
39
Example: Dissuading Consumption
- Anti-cigarette PSA’s decrease Marginal Private Benefit, or demand. - The welfare loss shrinks as the equilibrium price and quantity move closer to the social optimum
40
Property Rights (Coase Theorem)
- Assigning property rights can correct for an externality - Economic externalities that previously affected a third party must be considered by parties in a transaction involving the externality
41
Coase Theorem is Possible If
- Property rights exist - Small no. of parties involved - Low transaction costs
42
Public Goods
- Goods available for all to consume, regardless of who pays and who doesn’t - Exhibit non-rivalry and non-excludability
43
Non-rivalry (non-diminishability)
No limitations on someone’s ability to consume a good from another party consuming that good
44
Non-excludability
The inability to prevent others from consuming a good
45
Lack of Public Goods
- Market fails to provide public goods due to unwillingness to fund them - Individual buyers for a collective product
46
Free Rider Problem
Parties are naturally tempted to let others pay for a good and receive the benefit of said good without paying
47
Solutions to Free Rider Problem
- Government provides public goods, forcing people to pay via taxes - Finding ways to exclude non-paying parties (ex: private roads)
48
Public-private partnerships
Government finances establishment of a public good before allowing a private producer to operate it (and exclude non-paying parties)
49
Merit Goods
- Goods where social benefits exceed private benefits - May be provided by private or public sector - Ex: Healthcare, education, roads
50
Encouraging Consumption of Merit Good
- Subsidizing consumption to increase quantity demanded - Advertising benefits of good/service to increase marginal private benefit
51
Demerit Goods
- Goods where private benefits exceed social benefit, leading to market failure - Ex: Cigarettes, alcohol, gambling
52
Solutions to Demerit Good
Taxing, regulating or prohibiting consumption of good
53
Tragedy of the Commons
Absence of incentives to prevent overuse and depletion of a commonly owned resource
54
Common Access Resource Attributes
- Rivalrous and non-excludable - Unable to exclude other users - Use of a good depletes availability of good for others
55
Collective Self-Governance
- Communities who use resource have greatest incentive to develop roles to manage shared resources. - No “one size fits all” approach works.
56
International Cooperation
Nations agree on goals to manage commonly owned resources sustainably
57
Problem of International Cooperation
- Assessing size of external costs (size of welfare loss triangle) difficult due to global nature of problem - Difficult to enforce and monitor progress of other countries
58
Sustainable development of developing countries
- Developing countries rely on natural resources for export earnings - Excessive natural resource use can lead to environmentally unsustainable development
59
Extension of Property Rights
Extension of property rights to encourage protection & management of scarce resources (Coase theorem)
60
Issue with Extension of Property Rights
Difficult to implement for policy makers on large scale
61
Carbon Taxes
- Charge levied by government on firms burning fossil fuels - Forces firms to internalize externality by paying external cost
62
Problems with Carbon Taxes
Estimating amount of tax to levy for allocative efficiency can be difficult
63
Tradable Permits/Cap & Trade [A]
- Government licenses permitted amount of pollution in shares/permits - Market is created for permits
64
Tradable Permits/Cap & Trade [B]
- Greater demand for permits makes polluting more expensive - Forces firms to reduce pollution - Relies on enforcement & heavy fines to gain compliance
65
Factor Immobility
- Resources supposed to move to places where needed most (ex: labor to highest wages) - Immobility of factors limit socially optimum outcomes
66
Inequality
- Free markets can lead to significant inequality - Ex: lack of opportunities limit education and potential income
67
Policy Failure
Governments placing political interests ahead of socially optimal economic outcomes

Economics SL (Year 2) - IB (3 decks)

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