Market Failure, Externalities 3A

Question 1

22

What is economic efficiency?

Answer 1

Allocative + Productive efficiency

Question 2

(Rev) What is allocative and productive efficiency?

Answer 2

Allocative: Right amt of right goods produced.
- 1 point on PPC (most desired by society)
- MSB=MSC

Productive:
Max output for given input
- [Firms] produce on long run avg cost curves using least cost combination
- [Considered to be productively efficient -> profit driven]

Question 3

What is equity?

Answer 3

Distribution of resources that’s fair
Inequity-> unfair resource allocation

Free markets -> productive efficient, but Resource allocation ≠ Equitable outcomes

Question 4

What are the 3 functions of the price mechanism? (IRS)

Answer 4

Incentive
Incentivises prices will ration processed food to consumers
who are willing and able to cast higher dollar votes for processed food.

Rationing
distributed according to the
willingness and ability of consumers to pay for it. increasedprices will ration processed food to consumers
who are willing and able to cast higher dollar votes for processed food.

Signalling
Consumers signal the increase in dd by casting more dollar votes. This is represented by a rightward shift of the demand curve

The increase in price signals to processed food
producers to allocate resources to produce more as a result of the incentive
of earning greater profits per unit.

Question 5

What is the meaning of market failure?

Answer 5

Market failure
-> Describes circumstances in which DISTORTIONS in markets PREVENT price mechanism from allocating resources efficiently, lead to welfare loss

Question 6

What are the sources of market failure?

Answer 6

+ve externality
- ve externality
Info failure
Info failure (Asymmetric info)
Public goods
Market dominance
Factor immobility

Question 7

What policies tackle market failure? (+ Inequity)

Answer 7

MARKET
Taxes, subsidies, permits

RULES/LEGISLATION
Legislation on production/consumption

(Policies)
Direct or joint provision

Question 8

What are positive/negative externalities?

Answer 8

External benefit/cost with beneficial/harmful effect on third parties resulting from consumption/production of good/service NOT compensated for.

Eg. Healthcare costs on 2nd hand smoker, more literate society hence higher productivity

Question 9

PDSAD for +ve ext.

Answer 9

Private output: MPC intersects MPB (Explain w qn context)

Divergence betw MSB & MPB (MEB arises due to +ve ext.
MPC=MSC assume no -ve ext.

Socially optimal output
MSB=MSC (output at Q*, right of Q)
Society takes into account all costs & benefits

Allocative inefficiency
At Q MSB>MSC, last unit of output adds more to benefit than cost, underconsumption/underproduction

DWL
Area _ lost due to net benefit lost due to underproduction/consumption
Market fails, allocative efficiency not achieved, DWL

Question 10

Explain subsidies+ effectiveness

Answer 10

[WHAT]
- By govt given to producer
- decrease in COP

[HOW]
-given at cd (equivalent to MEB at Q*)

[HOW WELL]
+ Flexible
+ Incentive
+ Reduces inequity

• Difficult to measure ext benefit
  Problems of financing:
  • Disincentive argument
  • Budget Deficit argument
  • Opp cost arg.
• Unanticipated factors

Question 11

Explain legislation and effectiveness

Answer 11

[WHAT]
- Rules & Regulations

[How]
- Directly influence consumers’ behaviour, compliant to avoid punitive measures

+ easy to understand & implement
+ Certainty of outcome

• Costly (enforcement)
• Blunt instrument (no customisation)

Question 12

Explain direct provision + effectiveness

Answer 12

Govt directly controls supply (100% subsidy)

+ Ensures socially optimal provided
+ Govt controls qty & quality
+ Reduces inequity

• Difficult to gather info, Hard to est. right amt
• Problems of financing
  DISCENTIVE arg.
  BUDGET DEFICIT arg.
  OPP COST arg.

Question 13

PDSAD for -ve ext.

Answer 13

P: MPB=MPC Consumer consumes output lvel where private welfare maximised, ignoring MEC

D: Presence of -ve ext, MSC> MPC due to MEC [give context to qn]

S: Q, society takes into acc all Cost & benefit

A: allocative inefficiency MSC>MSB last unit of good consumed adds to more cost than benefit, OVERCONSUMPTION

D: DWL of area ___

Question 14

Explain PDSAD for info failure (can be under or over)

Answer 14

P: MPC perceived = MPB
D: MPC perceived < MPC actual
S: MPC actual=MSC = MSB
A: allocative inefficient
D: DWL

Question 15

Govt intervention for -ve ext or info failure

Answer 15

• Subsidies / Direct provision (for underest. or dk benefit)
• Taxes (for underest or dk cost)

Works for both
- Legislation
- Provision of info

Question 16

Explain 3 problems of financing
(Subsidies/direct provision)

Answer 16

DISINCENTIVE
- HIgh tax imposed to finance sub.
- Lower productivity capacity
- discourage investment

BUDGET DEFICIT
- Benefit of reducing budget deficit > gain in external benefit = misallocation of resources
- Lowers credit rating, less foreign investment

OPP COST
- Funded w. resources w other uses
- Loss in benefits > gain in benefits from subsidy, misallocation of resources

Question 17

3 characteristics of public goods

Answer 17

1. Non rivalrous
   - 1 additional person doesn’t diminish another’s ability to consume
2. Non excludable
   - Not feasible to exclude someone else from a good
3. Non rejectable (not impt)
   - inability to refuse

Question 18

How public goods lead to market failure

Answer 18

Non rivalrous -> additional cost of providing another = 0
MC = 0 efficient price = 0
NO PROFIT MOTIVATED FIRMS WILLING TO SUPPLY

Non excludable -> FREE RIDER PROBLEM

No supply & No demand -> no mkt