Market failures Flashcards
Define consumer surplus formula
Maximum price consumer is willing to pay - the actual price
- represents the added benefit (because not having to pay much or if consumer surplus is low, they have to pay a lot :( )
Define producer surplus’ formula
Total revenue - total cost = producer surplus
- additional benefits (money)
When does market failure occur?
when the price mechanisms not optimum — basically when it fails to create a market equilibrium
Why is getting the optimum social surplus impossible?
Everyone has their different economics goals and no matter what, someone would be at a disadvantage
-> negative externalities
Why are negative externalities not regarded by producers or consumers
Cannot be aligned with economic goal
- negative externalities not quantifiable by profit
Outline the resukts of inefficient allocation of resources
- under-provision of certain goods and services [producers] (e.g. from taxes)
- over-provision of certain goods (e.g. from subsidies, price floors)
- under and over consumption of goods
Outline some examples of market failure
The under-provision of merit goods such as education and healthcare
Why do private schools and private hospitals not lower their prices
To maximize profit
When the gov can’t give the services, who would step up?
The producers
When there’s a shortage of labor, who should step up and how?
The government
- can incentivize
- making migration more difficult etc
Define private costs
costs incurred by the consumption or production of goods and services (main economic agents — producers and consumers)
Define externalities
External costs costs or benefits of an economic transaction (selling, buying) that causes the market to fail to achieve the social optimum level of production or consumption
(e.g. fertilizers, air pollution, second-hand smokers etc.)
Define social optimum level of production or consumption
MSC = MSB
Differentiate external benefits and external costs
External costs AKA negative externalities - adverse impacts to third parties (ie. society)
Internal costs AKA positive externalities - positive impacts to third parties
Define private benefits
Advantages enjoyed by an indv or company and/or consumers
Define private costs
actual expenses from buying or producing something
Define social benefits
social benefits = private benefits + positive externalities
-> benefits to the whole society
-> 3rd party (w/o econ agents): pos ext.;
-> economic agents: private ben.;
Define social costs
social costs = private costs + negative externalities
-> costs incurred by the whole society (3rd parties + consuemrs and producers)
Define marginal private benefits (MPB)
additional value enjoyed by households and firms
- after production or consumption of additional unit of output
Define marginal social benefits (MSB)
total gains enjoyed by households and firms and everyone else
- after production or consumption of additional unit of output
Marginal private cost and margincal social cost (CONT)
Describe the social surplus/community surplus
X is allocative efficient (equilibrium price = quantity)
Why can positive externalities can cause market failure?
When MSC < MSB (??):
-market tends to produce less of a good or service with external benefits than is socially optimal;
- due to individuals do not consider the benefits to society
How can merit goods cause market failure
Since merit goods are both rivalrous and excludable,
- merit goods tend to be under-consumed and underproduced due to the irrational nature and imperfect info (they don’t know what is good and bad for them)
Outline the two types of merit goods
1.) Rivalrous
2.) Excludable
Define rivalrous merit goods.
Consumption of. a merit good reduces the available units to others
Define excludable goods
Possible for producers to prevent non payers benefiting from the merit good (private health care, educ, etc.)
Describe this positive externality of consumption graph
There are two demand curves — there’s a difference between the MPB and the MSB.
MSB > MPB
How to know if its underconsumed or overconsumed?
Look at Qopt (optimum quantity consumed)
Describe this graph/differentiate it from the negative externalities
Green triangle = DWL loss due to [in this case] underproduction.
In this case, the difference is between the MPC and MSC (the «S») AND the position of the DWL
- if DWL for neg externalities: base facing right — the DWL of 3rd parties
- if DWL for positive externalities: base facing left — the DWL of producers and consumers
Define negative externalities/external costs
expenses with no compensation felt by the third parties not quantifiable by money
- e.g. pollution, littering, climate change, obesity rates
Why are junk foods demerit goods?
Can increase obesity rates — its not a necessity
Why is excessive ads bad (neg externality?)
Creates visual blight
Why do negative externalities lead to MSC > MPC
The production and consumption results in greater marginal costs (e.g. obesity)
Outline some examples of demerit goods
High caffeine, tobacco products, hands-free mobile phones in vehicles (leads to more car accidents)
What would happen when there’s no gov intervention
Demerit goods are over-produced and over-consumed from society’s POV
- consumers and producers merely concerned with their goals — don’t care about the externalities
Why are meats demerit goods?
Environmental impacts
Describe this graph
MPC > MSC
Equilibrium — when MSC and MPC RESPECTIVELY = MPB = MSB
The MPB and MSB curve is aligned
How to explain
Explain this graph
1.) Introduction (consumption -> negative externalities)
2.) Give examples
3.) MSB < MPB
(because MSC > MPC?)
Pe = price of the economy currently
Popt = where the economy should be
Why is MPB < MSB not the socially optimum point?
- means resources are underutilized;
-
society can benefit from the production of more resources;
-> (because the costs in the externalities graph are the supply curve)
What is Qe?
Socially optimum quantity
What are the rules when creating an externality diagram?
1.) In a production externality, the supply curve splits into two; in a consumption externality, the demand curve splits into two.
2.) Supply reflects costs; demand reflects benefits.
3.) The market equilibrium quantity Qe corresponds to private costs and benefits, MPC and MPB; the social optimum reflects social costs or benefits.
4 .) In a *negative externality *Qe > Qopt**, meaning that the market provides too much of a bad thing; in a positive externality Qm < Qopt, meaning that the market provides too much of a good thing.
Steps to draw an externality diagram
Describe public goods
Any good or service not provided by the free market
- non-excludable and non-rivalrous; (more on consumption)
-> all included and no competition — so everyone can have w/o paying
- e.g.: street lights, ligthouses, sports centres, public education,
Describe excludable
If one person pays for it but one can’t, the one who can’t is excluded from having a certain good and service
Define free-rider
Those who benefit without contribution
What kind of problem do public goods pose?
A free-rider problem meaning that is difficult to prevent people who do not pay for the good from consuming it
why is IB such an excludable institution
Very expensive but it is non-rivalrous (so I guess, depending on the situation, you don’t need to compete to get in)
Give examples of the free rider problem
e.g.: lazy unemployed people (tax payers pay for their well-being)
How will the free-rider problem result to market failure?
The under-provision of the goods and services because individuals consume more and benefitting despite not contributing
- under-production OR over-consumption —> tragedy of the commons
- basta the goods and services not enough
Define tragedy of the commons
Free-riders exploit public goods (e.g. lakes, forests, etc etc) which leads to loss of life/v sustainability.
(- so basically free riders exploit public goods related to the environment, v sustainability)
Describe quasi-public goods
- Neither public or private goods
- non-rivalrous (comme public goods) but excludable (comme private goods)
- ex: museums that charge an entrance fee (like the one in Roma :’) ), toll booths along the road (like in SLEX)
Why are common access resources so easily exploited?
Producers will get these common access resourcers or the consumers will keeping using these for their own resources
- results in the tragedy of the commons
- e.g.: forests, rivers, water, valleys, lakes
Define common access resources
resources which are not owned by anyone, do not have a price and are available for anyone to use without payment
Why does the tragedy of the commons happen
Difficult and expensive to exclude people from these environmental goods
- (but there are measures such as the name of the “Suicide Forest” in Japan)
Tragedy of the Commons vs. the Free Rider Problem
Free-rider problem:
- more on the lack of contribution yet still benefiting
Tragedy of the commons:
- Consumers just consuming without thinking about sustainability (environment, resources, others, etc)
What is the best answer to the Tragedy of the Commons?
Direct provision (because the goods are non-excludable — can’t use price)
- government can ask private firms to produce for them // they contract
- e.g.: PH gov and San Miguel and Villar-owned companies to make roads.
Arguments in favour of direct provision of public goods include:
- gen public just receives what the gov provides/ gen public support
- public goods wouldn’t be available if not for direct provision
- enables large-scale productions
Arguments NOT in favor of direct provision
- The government cost (#deadweightloss)
- The opportunity cost — gov spending could be used elsewhere
- potential government failure for intervening in markets (link to key assumption)
- THEY DON’T KNOW HOW MARKETS WORK T-T (that is why businessmen become politicians) — therefore this point might be void in the future
Define bureaucracy
- Making sure that the person accountable for allowing something to happen has a signature
How does the government will calculate for the optimal allocation
- using MSB and MSC
- MSB > MSC —> under allocation of the public good
- MSC > MSB —> overconsumption (costs do not have to be monetary — can just be like pollution or costs to environment)
Define asymmetric information (HL only)
When one side has more information than another
What would happen if sellers have more information?
Can result in a market failure as v demand due to lack of trust (shift to the left)
- affects the truthful sellers as well
What would happen when buyers have more info?
Market failure..? — Buyers could have more surplus than producers (can pay less)
- e.g.: insurance (buyer can downplay his riskiness)
(also get health insurance as early as possible)
Define the economic importance of information
Essential for making sensible and rational econ. decisions
-> (if imperfect information -> market inefficiencies -> market failure)
Define asymmetric unformation [2]
Source of market failure that exists when one econ. agent has more info than the other in an econ. transaction
- incomplete or inaccessible information
What does economic theory suggest how we can attain equilibrium information-wise?
When there’s perfect knowledge
- (readily available information which is evenly sharedby all economic agents in an econ. transaction)
Why does asymmetric information cause market failure?
Becayse the party with more info has an unfair advantage over the over -> inefficiencies and a misallocation of resources due to distorted decision-making
OUTLINE THE EFFECTS OF ASYMMETRIC INFORMATION
- market failure -> due to distorted decision making
- two forms of opportunistic behavior: adverse selection and moral hazard
Define adverse selection
Undesired decisions due to power imbalances caused by asymmetric info
Define moral hazard
One party engages in risky behavior because they know that the other party bears the economic consequences of their behavior
Give an example of the government creating a moral hazard
VIa balouts
- send a message to the executives of large corporations that engaging in VERY risky business decisions is ok because they’ll be shouldered by someone else
How can government interventions fight asymmetric information
- Via legislation, they can make information legally required to be seen by all parties (e.g. transparency clauses, building regs, legal contracts)
- Direct provision of information — e.g. nutrition guidances
- licences can also be used — e.g. due to the licence you must state yayaya.
Define legislation
laws stipulated by the government.
Define provision of information
government provides additional information
(e.g. gov television broadcasts)
Why is regulation and legislation required to tackle asymmetric info?
In what instance can the government be considered a moral hazard
Gov makes a mistake, taxpayers face consequences as they pay for gov
TZo which parties can the gov legislations against asymm info refer to?
can be both/either producers and consumers
Example of gov legislation against asymm info (consumers)
Legal age for drinking etc etc
Market power
The business’ level of influence over market priuce
Define barrier to entry
what hinders a business to enter a market
