Market Failure & Government Intervention

Question 1

What is market failure?

Answer 1

Market failure refers to the failure of the free market to allocate resources efficiently.

Question 2

What is a free market?

Answer 2

A free market refers to a market free from government intervention.

Question 3

What is allocative efficiency?

Answer 3

It is a situation where the combination of g+s produced maximises the total economic welfare of society.

Question 4

What is marginal private benefit?

Answer 4

The additional utility derived from consuming an additional unit of the good.

Question 5

What is marginal private cost?

Answer 5

The additional cost of consuming one more unit of the good

equivalent to price consumers pay for the good

Question 6

What is consumer surplus?

Answer 6

The difference between the price that consumers are w+a to pay for the unit of good or service and the market price they actually pay.

Question 7

What is producer surplus?

Answer 7

The difference between what producers are w+a to supply the unit of good for and the price they actually receive

Question 8

When is allocative efficiency maximised?

Answer 8

Allocative efficiency is achieved when the sum of consumer surplus and producer surplus are maximised.

Question 9

What is an externality?

Answer 9

An externality refers to a +ve or -ve impact on a third party not involved in the consumption or production of a good or service.

Question 10

What is marginal external benefit?

Answer 10

It is the additional benefit enjoyed, from the production or consumption of the additional unit of a good by third parties who are not directly involved in the production or consumption of the good.

Question 11

What is marginal external cost?

Answer 11

The additional cost imposed, by the production or consumption of the additional unit of a good, on third parties who are not directly involved in the production or consumption of that good.

Question 12

What is a public good?

Answer 12

A public good is a good that is non-excludable, non-rivalrous and non-rejectable.

Question 13

What is non-excludability?

Answer 13

Non-excludability means that it is impossible or very costly to prevent someone who has not paid from consuming the good.

Question 14

What is non-rivalry?

Answer 14

Non-rivalry means that consumption of the good by one person does not diminish the availability of the good for another person.

Question 15

What is non-rejectability?

Answer 15

Non-rejectability means that there is an inability of consumers to refuse the consumption of a good once it has been produced.

Question 16

Why does market failure occur for public goods?

Answer 16

Non-excludable, impossible for producers to exclude those who have not paid from consuming –> consumers can be free riders that benefit from the good without paying –> no consumers willing to pay for public goods –> no effective demand –> producers unable to sell their good at any +ve price level –> no profit motivated private producers w+a to supply public good

Left to the free market, no production of public goods –> total market failure –> potential net benefit to society from having some level of public good produced and consumed is lost –> allocative inefficiency

Question 17

Framework for +ve externalities.

Answer 17

Paragraph:
1. Define and illustrate problem
Enjoy a +ve externality which is an external benefit to third parties not involved in the consumption of the good.
2. +ve externality causes MSB curve > MPB curve
3. Consumers base decisions on MPB and disregard MEB. assume no -ve externalities, MPC = MSC. Market equilibrium output at Q where demand equals supply and price at P.
4. Socially optimal output at Q’ and P’, where MSB = MSC and society’s welfare is maximised. +ve externality results in underconsumption of Q’ - Q units, resulting in welfare loss to society. For Q to Q’, MSB > MSC, there is a gain to society if Q’ Q units are consumed.
5. Deadweight loss represented by area A given that total social benefits greater than total social costs.

Question 18

Framework for -ve externalities.

Answer 18

Paragraph:
1. Define and illustrate problem
-ve externality which is an external cost to third parties not involved in the consumption of the good.
2. -ve externality causes MSC curve > MPC curve
3. Producers base decisions on MPC and disregard MEC. assume no +ve externalities, MPB = MSB. Market equilibrium output at Q where demand equals supply and price at P.
4. Socially optimal output at Q’ and P’, where MSB = MSC and society’s welfare is maximised. -ve externality results in overproduction of Q’ - Q units, resulting in welfare loss to society. For Q to Q’, MSC > MSB, there is a loss to society welfare from additional Q’ Q units produced.
5. Deadweight loss represented by area A given that total social costs greater than total social benefits

Question 19

What is consumer ignorance?