market failure microeconomics Flashcards
definition of market failure
When there is an inefficient allocation of resources in a free market
what is partial market failure?
When the market of a product still exists however at the wrong price or wrong quantity produced
what is complete market failure?
when there is a missing market
definition of externalities
spill-over effects from production and or consumption to a third party
how do externalities cause market failure?
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
what is the social optimum
where marginal social cost (marginal private costs + marginal external costs) = marginal social benefit (marginal private benefits + marginal external benefits).
It takes externalities into account
what are positive production externalities?
There is under-production - society would like more to be produced in this market.
private costs > social costs.
what are negative production externalities?
- 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
what are positive consumption externalities?
- under consumption of a good or service
- private benefits < social benefits
- e.g. wearing a face mask in a public place, free school meals
What are negative consumption externalities?
- over consumption of a good or service
- private benefits > social benefits
- e.g. smoking
definition of private costs
internal costs faced by the consumer or producer directly involved in the transaction
definition of external costs
when the activity of one agent has spill-over negative effects on the well-being of a third party
definition of private benefit
the benefit, satisfaction or utility that the agent directly involved in the transaction faces due to producing or consuming something
definition of external benefit
include private benefits but also the social benefits that may occur from production and/or consumption
why are externalities inevitable?
- 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)
definition of merit goods
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
what is a de-merit good
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
what is imperfect information
when people have inaccurate, incomplete, uncertain or misunderstood data so may potentially make the ‘wrong choices’
what are public goods?
goods which are non rival (consumption by one person does not reduce the supply available for others), non-excludable (benefits derived from them cannot)
what is the free-rider problem
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
how does the free-rider problem cause market failure?
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
what are examples of public goods?
- crime control
- street lights
- flood defence projects
- sanitation infrastructure
what are quasi-public goods
- 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)
examples of quasi-public goods
- free wifi
- crowded beaches
- busy urban parks
what are private goods?
= 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
examples of private goods
- houses
- food
- cars
what is asymmetric information
a situation in which one party in a transaction has more or better information than the other
what is moral hazard?
when the party with superior information alters their behaviour that benefits themselves whilst imposing costs on those with less information
why does asymmetric information cause market failure?
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.
what is a monopoly?
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)
why may monopolies cause the misallocation of resources (market failure)
- 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.
factors which may explain why monopolies exist:
- 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)
