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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
Q

MC of an extra unit < MB of consumption

A

Optimal to increase production from underproduction (and use additional resources for the better use)

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26
Q

MC of an extra unit > MB of consumption

A

Optimal to decrease production from overproduction (and release resources for better uses)

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27
Q

Positive Externalities and Optimal Production

A
  • Private optimal amount to produce < socially optimal amount
  • Loss in net benefit from underproduction
28
Q

Solution to externality: internalizing the externality

A

Make the private cost/benefit equal the social cost/benefit of an economic activity

29
Q

Issue with internalizing the externality

A

Can be difficult to calculate & prioritize costs vs. benefits of an activity, particularly externalities

30
Q

Job Security and Externalities

A

Must weigh job security when reducing an externality means reducing the revenue of a firm

31
Q

Subsidies

A
  • Subsidize firm’s costs of producing good
  • Will shift MPC curve to the right towards the MSC curve
32
Q

Issues with Subsidies

A

Create taxpayer burden & appeals from non-subsidized firms

33
Q

Indirect Tax

A
  • Shifting MPC leftwards to correct for a negative production-based externality
  • Useful when government knows how much to shift MPC
34
Q

Issues of Indirect Tax

A

Optimal degree to shift MPC can be difficult to determine

35
Q

Legislation

A
  • Governments can ban/limit consumption/use of certain goods
  • Creates enforcement costs and potential black market activities
36
Q

Advertising & Persuasion Goal

A

Bring equilibrium price & quantity closer to social optimum, where MSB = MSC

37
Q

Advertising & Persuasion (discouraging)

A
  • Government dissuades consumers from product via PSAs
  • Ex: cigarette ads, drinking and driving
  • Opportunity costs of producing, distributing PSAs
38
Q

Advertising & Persuasion (encouraging)

A
  • Government advertises benefits of using product/service
  • Ex: Advertising to promote flu vaccinations
39
Q

Example: Dissuading Consumption

A
  • 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
Q

Property Rights (Coase Theorem)

A
  • 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
Q

Coase Theorem is Possible If

A
  • Property rights exist
  • Small no. of parties involved
  • Low transaction costs
42
Q

Public Goods

A
  • Goods available for all to consume, regardless of who pays and who doesn’t
  • Exhibit non-rivalry and non-excludability
43
Q

Non-rivalry (non-diminishability)

A

No limitations on someone’s ability to consume a good from another party consuming that good

44
Q

Non-excludability

A

The inability to prevent others from consuming a good

45
Q

Lack of Public Goods

A
  • Market fails to provide public goods due to unwillingness to fund them
  • Individual buyers for a collective product
46
Q

Free Rider Problem

A

Parties are naturally tempted to let others pay for a good and receive the benefit of said good without paying

47
Q

Solutions to Free Rider Problem

A
  • Government provides public goods, forcing people to pay via taxes
  • Finding ways to exclude non-paying parties (ex: private roads)
48
Q

Public-private partnerships

A

Government finances establishment of a public good before allowing a private producer to operate it (and exclude non-paying parties)

49
Q

Merit Goods

A
  • Goods where social benefits exceed private benefits
  • May be provided by private or public sector
  • Ex: Healthcare, education, roads
50
Q

Encouraging Consumption of Merit Good

A
  • Subsidizing consumption to increase quantity demanded
  • Advertising benefits of good/service to increase marginal private benefit
51
Q

Demerit Goods

A
  • Goods where private benefits exceed social benefit, leading to market failure
  • Ex: Cigarettes, alcohol, gambling
52
Q

Solutions to Demerit Good

A

Taxing, regulating or prohibiting consumption of good

53
Q

Tragedy of the Commons

A

Absence of incentives to prevent overuse and depletion of a commonly owned resource

54
Q

Common Access Resource Attributes

A
  • Rivalrous and non-excludable
  • Unable to exclude other users
  • Use of a good depletes availability of good for others
55
Q

Collective Self-Governance

A
  • Communities who use resource have greatest incentive to develop roles to manage shared resources.
  • No “one size fits all” approach works.
56
Q

International Cooperation

A

Nations agree on goals to manage commonly owned resources sustainably

57
Q

Problem of International Cooperation

A
  • 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
Q

Sustainable development of developing countries

A
  • Developing countries rely on natural resources for export earnings
  • Excessive natural resource use can lead to environmentally unsustainable development
59
Q

Extension of Property Rights

A

Extension of property rights to encourage protection & management of scarce resources (Coase theorem)

60
Q

Issue with Extension of Property Rights

A

Difficult to implement for policy makers on large scale

61
Q

Carbon Taxes

A
  • Charge levied by government on firms burning fossil fuels
  • Forces firms to internalize externality by paying external cost
62
Q

Problems with Carbon Taxes

A

Estimating amount of tax to levy for allocative efficiency can be difficult

63
Q

Tradable Permits/Cap & Trade [A]

A
  • Government licenses permitted amount of pollution in shares/permits
  • Market is created for permits
64
Q

Tradable Permits/Cap & Trade [B]

A
  • Greater demand for permits makes polluting more expensive
  • Forces firms to reduce pollution
  • Relies on enforcement & heavy fines to gain compliance
65
Q

Factor Immobility

A
  • Resources supposed to move to places where needed most (ex: labor to highest wages)
  • Immobility of factors limit socially optimum outcomes
66
Q

Inequality

A
  • Free markets can lead to significant inequality
  • Ex: lack of opportunities limit education and potential income
67
Q

Policy Failure

A

Governments placing political interests ahead of socially optimal economic outcomes

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

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