Market Failure- Theme 1

Question 1

Define market failure

Answer 1

When price mechanism causes an inefficient allocation of resources, leading to a net welfare loss. Consequently, resources are not allocated to their best or optimum use.

Question 2

Define external costs

Answer 2

Negative third-party effects outside of a market transaction. E.g. someone smoking.

Question 3

Define private costs

Answer 3

Costs internal to a market transaction, which are therefore taken into account by the price mechanism.

Question 4

Define social costs

Answer 4

The sum of external costs and private costs from a market transaction.

Question 5

Define external benefits

Answer 5

Positive third-party effects outside of a market transaction. E.g. increase house prices for homeowners near an urban regeneration schemes.

Question 6

Define private benefits

Answer 6

Benefits internal to a market transaction, which are therefore taken into account by the price mechanism.

Question 7

Define social benefits

Answer 7

The sum of external benefits and private benefits from a market transaction.

Question 8

Give and example of an external cost for production

Answer 8

A waste disposable firm dumping toxic waste at sea, which destroys fish life.

Question 9

Give and example of an external benefits for production

Answer 9

A paper and glass recycling plant, which reduces the waste for landfill sites.

Question 10

Give and example of an external cost for consumption

Answer 10

Excess alcohol intake, leads to vandalism and violence.

Question 11

Give and example of an external benefit for consumption

Answer 11

Education and training programmes, increase human capital levels. Higher labour productivity increases profits for firms.

Question 12

Define market equilibrium

Answer 12

Where marginal private benefit equals marginal private cost.

Question 13

Define social optimum equilibrium level of output

Answer 13

Where marginal social benefit equals marginal social cost.

Question 14

What is the triangle of welfare loss?

Answer 14

The excess of social costs over social benefits is shown by a triangle. This is the area of welfare loss to society; he market has failed, since negative externalities are ignored.

Question 15

What is the triangle of welfare gain?

Answer 15

The excess of social benefits over social costs is shown by the triangle, this is the the area of welfare gain to society; the market has failed, since positive externalities are ignored.

Question 16

What are the impacts of external costs on consumers and producers?

Answer 16

• overproduction, since free market level of output exceeds social optimum level of output.
• underpricing, since free market price below social optimum price.
• welfare loss, since marginal social costs exceed marginal social benefits
• concerns over availability of resources and pollution levels

Question 17

What are the impacts of external benefits on consumers and producers?

Answer 17

• underproduction since free market level of output is less than social optimum level of output
• underpricing, since free market price below social optimum price
• potential welfare gain, since marginal social benefits exceed marginal social costs
• concerns over long-term implications of underproduction.

Question 18

Define public goods

Answer 18

Those goods that have non-rivalry and non-excludability in their consumption.eg natural defence.

Question 19

Define non-excludability

Answer 19

Once the good has been produced for the benefit of one person, it’s impossible to stop others from benefiting.

Question 20

Define non-rivalry

Answer 20

As more people consume a good and enjoy its benefit, it doesn’t reduce the amount available for others.

Question 21

Define private goods

Answer 21

Those goods that have rivalry and excludability in their consumptions.

Question 22

What is meant by the free-rider problem?

Answer 22

When the market fails because its not possible for firms to withhold the good from those consumers who refuse to pay for it

Question 23

Define information gaps

Answer 23

Where consumers, producers or the government have insufficient knowledge to make rational economic decisions.

Question 24

Define symmetric information

Answer 24

Where consumers and producers have access to the same information about a good or service in the market.

Question 25

Define asymmetric information

Answer 25

Where consumers and producers have unequal access to information about a good or service in the market.