Market Failure Definitions

Question 1

market failure

Answer 1

Market Failure is defined as the failure of the free market to achieve allocative
efficiency, resulting in the over-allocation or under-allocation of resources
relative to the socially efficient level, or to achieve equity.

Question 2

allocative efficiency

Answer 2

Allocative Efficiency is the situation in which society produces and consumes a
combination of goods and services that maximises its welfare. It is achieved when goods and
services wanted by the economy are produced in the correct quantities.

Question 3

criteria for allocative efficiency

Answer 3

1. Society produces at a point on the PPC
2. Price equals Marginal Cost of production (P = MC)
3. Marginal Social Benefit (MSB) = Marginal Social Cost (MSC)

Question 4

equity

Answer 4

Equity is the concept of fairness in society, referring to equal life chances regardless of
identity, providing all citizens with a basic minimum amount of income, goods and services
or to increase funds for redistribution.

Question 5

externalities

Answer 5

Externalities are spillover costs or benefits to third parties who are not directly
involved in the production or consumption of goods and services.

Question 6

marginal private cost (mpc)

Answer 6

Marginal Private Cost (MPC) refers to the additional cost incurred by producers or
consumers who produce or consume an additional unit of the good.

Question 7

marginal external cost (mec)

Answer 7

Marginal External Cost (MEC) refers to the cost incurred by the production or
consumption of an additional unit of a good on third parties (3rd Party Effects) who are
not directly involved in the production or consumption of the goods.

Question 8

marginal social cost (msc)

Answer 8

Marginal Social Cost (MSC) refers to the government’s consideration, which is the sum of the MPC and MEC, which is the total opportunity cost to society in the production and consumption of an additional unit of a good (both private and external costs are taken into
consideration).

Question 9

msc = ____________ + ___________

Answer 9

MSC = MPC + MEC

Question 10

marginal private benefit (mpb)

Answer 10

Marginal Private Benefit (MPB) refers to the benefits that producers or
consumers can obtain from the production or consumption of an additional unit
of the good from the producers’ and consumers’ perspectives.q

Question 11

marginal external benefit (meb)

Answer 11

Marginal External Benefit (MEB) refers to the benefits gained by the production or consumption of an additional unit of a good on third parties (3rd Party Effects) who are not directly involved in the production or consumption of the goods.

Question 12

marginal social benefit (msb)

Answer 12

Marginal Social Benefit (MSB) refers to the government’s considerations, which is the
sum of the MPB and MEB, which is the total benefit gained by society in the production and consumption of an additional unit of a good (both private and external benefits are taken
into consideration.

Question 13

msb = ____________ + ___________

Answer 13

MSB = MPB + MEB

Question 14

negative externalities

Answer 14

Negative externalities occur when external costs are incurred by 3rd parties due to the production of goods or services by firms or the consumption of goods or services by
consumers.

Question 15

positive externalities

Answer 15

Positive externalities occur when external benefits are obtained by 3rd parties due to the
production of goods or services by firms or the consumption of goods or services by
consumers.

Question 16

merit goods

Answer 16

Merit goods are goods that are generally under consumed and deemed to be socially
desirable by the government for consumers and the rest of society (3rd Parties).

Question 17

Why are merit goods underconsumed?

Answer 17

Merit Goods are generally under-consumed for three reasons:
1. Imperfect Information
2. Income Inequality
3. Presence of Positive Externalities

Question 18

demerit goods

Answer 18

Demerit goods are goods that are generally over consumed and deemed to be socially
undesirable by the government for consumers and society.

Question 19

Why are demerit goods overconsumed?

Answer 19

Demerit Goods are generally over-consumed for 2 reasons:
1. Imperfect information
2. Presence of negative externalities

Question 20

What are the three key characteristics of public goods?

Answer 20

1. non-rivalrous
2. non-excludable
3. non-rejectable

Question 21

non-rivalry

Answer 21

A good is non-rivalrous in consumption when the consumption of the good or service by
one person does not reduce the amount available to others.

Question 22

non-excludability

Answer 22

A good is non-excludable in consumption when it would be impossible or very costly to
exclude non-payers from consuming the good once it is provided.

Question 23

non-rejectability

Answer 23

The collective supply of a public good for all means that it cannot be rejected by
beneficiaries once the good is provided. Non-rejectability refers to the inability of
consumers to refuse the consumption of a good once it has been produced.