Market Failure- Theme 1 Flashcards
Define market failure
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.
Define external costs
Negative third-party effects outside of a market transaction. E.g. someone smoking.
Define private costs
Costs internal to a market transaction, which are therefore taken into account by the price mechanism.
Define social costs
The sum of external costs and private costs from a market transaction.
Define external benefits
Positive third-party effects outside of a market transaction. E.g. increase house prices for homeowners near an urban regeneration schemes.
Define private benefits
Benefits internal to a market transaction, which are therefore taken into account by the price mechanism.
Define social benefits
The sum of external benefits and private benefits from a market transaction.
Give and example of an external cost for production
A waste disposable firm dumping toxic waste at sea, which destroys fish life.
Give and example of an external benefits for production
A paper and glass recycling plant, which reduces the waste for landfill sites.
Give and example of an external cost for consumption
Excess alcohol intake, leads to vandalism and violence.
Give and example of an external benefit for consumption
Education and training programmes, increase human capital levels. Higher labour productivity increases profits for firms.
Define market equilibrium
Where marginal private benefit equals marginal private cost.
Define social optimum equilibrium level of output
Where marginal social benefit equals marginal social cost.
What is the triangle of welfare loss?
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.
What is the triangle of welfare gain?
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.
What are the impacts of external costs on consumers and producers?
- 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
What are the impacts of external benefits on consumers and producers?
- 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.
Define public goods
Those goods that have non-rivalry and non-excludability in their consumption.eg natural defence.
Define non-excludability
Once the good has been produced for the benefit of one person, it’s impossible to stop others from benefiting.
Define non-rivalry
As more people consume a good and enjoy its benefit, it doesn’t reduce the amount available for others.
Define private goods
Those goods that have rivalry and excludability in their consumptions.
What is meant by the free-rider problem?
When the market fails because its not possible for firms to withhold the good from those consumers who refuse to pay for it
Define information gaps
Where consumers, producers or the government have insufficient knowledge to make rational economic decisions.
Define symmetric information
Where consumers and producers have access to the same information about a good or service in the market.
Define asymmetric information
Where consumers and producers have unequal access to information about a good or service in the market.
