market failure microeconomics

Question 1

definition of market failure

Answer 1

When there is an inefficient allocation of resources in a free market

Question 2

what is partial market failure?

Answer 2

When the market of a product still exists however at the wrong price or wrong quantity produced

Question 3

what is complete market failure?

Answer 3

when there is a missing market

Question 4

definition of externalities

Answer 4

spill-over effects from production and or consumption to a third party

Question 5

how do externalities cause market failure?

Answer 5

They disrupt the efficient functioning of markets and lead to a net loss of welfare.
- the prices and quantities determined by supply and demand in the market do not account for these external costs or benefits

Question 6

what is the social optimum

Answer 6

where marginal social cost (marginal private costs + marginal external costs) = marginal social benefit (marginal private benefits + marginal external benefits).

It takes externalities into account

Question 7

what are positive production externalities?

Answer 7

There is under-production - society would like more to be produced in this market.
private costs > social costs.

Question 8

what are negative production externalities?

Answer 8

• There is an overproduction and society would like fewer resources allocated to this market.
• Private costs of production < social costs
• output is too high for social optimum

Question 9

what are positive consumption externalities?

Answer 9

• under consumption of a good or service
• private benefits < social benefits
• e.g. wearing a face mask in a public place, free school meals

Question 10

What are negative consumption externalities?

Answer 10

• over consumption of a good or service
• private benefits > social benefits
• e.g. smoking

Question 11

definition of private costs

Answer 11

internal costs faced by the consumer or producer directly involved in the transaction

Question 12

definition of external costs

Answer 12

when the activity of one agent has spill-over negative effects on the well-being of a third party

Question 13

definition of private benefit

Answer 13

the benefit, satisfaction or utility that the agent directly involved in the transaction faces due to producing or consuming something

Question 14

definition of external benefit

Answer 14

include private benefits but also the social benefits that may occur from production and/or consumption

Question 15

why are externalities inevitable?

Answer 15

• public goods exist
• the inter-connectedness of economic agents (in our economy firms, individuals and governments engage in a lot of economic activity causing them to have ripple effects to agents beyond the transaction)

Question 16

definition of merit goods

Answer 16

goods and services that the Government feel that people may under-consume. and therefore cause positive externalities
- they can be rival, excludable and rejectable
- society judges that people should have regardless of their ability to pay

Question 17

what is a de-merit good

Answer 17

goods that have negative externalities or adverse effects on society that are not fully recognised by those consuming the goods
- therefore may need government intervention

Question 18

what is imperfect information

Answer 18

when people have inaccurate, incomplete, uncertain or misunderstood data so may potentially make the ‘wrong choices’

Question 19

what are public goods?

Answer 19

goods which are non rival (consumption by one person does not reduce the supply available for others), non-excludable (benefits derived from them cannot)

Question 20

what is the free-rider problem

Answer 20

when people are benefiting from resources, goods, or services that they do not pay for.
- occurs with public goods due to them being non-excludable

Question 21

how does the free-rider problem cause market failure?

Answer 21

it leads to under-provision of a good because firms have a lack of incentive to produce due to reduced profit therefore leading to market failure due to missing markets
- Therefore most public goods are provided by the public sector

Question 22

what are examples of public goods?

Answer 22

• crime control
• street lights
• flood defence projects
• sanitation infrastructure

Question 23

what are quasi-public goods

Answer 23

• has some characteristics of a public good
• semi non-rival (up to a point the use by one person does not restrict the use by another, but they become crowded) e.g. beaches get crowded
• semi-non-excludable (it is possible but difficult or costly to exclude non-paying customers)

Question 24

examples of quasi-public goods

Answer 24

• free wifi
• crowded beaches
• busy urban parks

Question 25

what are private goods?

Answer 25

= they are excludable - meaning the good or service is limited to only paying customers
= they are rival - consumption by one consumer prevents simultaneous consumption by other consumers

Question 26

examples of private goods

Answer 26

• houses
• food
• cars

Question 27

what is asymmetric information

Answer 27

a situation in which one party in a transaction has more or better information than the other

Question 28

what is moral hazard?

Answer 28

when the party with superior information alters their behaviour that benefits themselves whilst imposing costs on those with less information

Question 29

why does asymmetric information cause market failure?

Answer 29

Due to adverse selection -> which is a market phenomenon that occurs when the parties involved in the transaction have asymmetric information. This leads to an imbalance in the transaction as the party with the advantage can use their superior information to make decisions that are not in the best interest of the other party.

Question 30

what is a monopoly?

Answer 30

when there is one supplier in the market.
-Firms can have monopoly power when they have 25+% of the market share (number of customers in the market)

Question 31

why may monopolies cause the misallocation of resources (market failure)

Answer 31

• there is a lack of competitive pressure so firms have less incentive to innovate/ work in the most efficient way. Therefore they are likely to be productively and allocatively inefficient due to not necessarily having to keep prices low.

Question 32

factors which may explain why monopolies exist:

Answer 32

• they can buy out their competitors
• locational advantage
• good advertisement
• anti competitive practice e.g. predatory pricing (the pricing of goods or services at such a low level that other firms cannot compete and are forced to leave the market)