Market Mechanism And Market And Government Failure Flashcards
What are the 4 functions of prices
Signalling
Rationing
Allocating
Incentive
Signalling function
Provides info to buyers and sellers to manage economic activity
After signalling what does the incentive function mean
Firms will alter price to achieve greater profit. May be excess supply or demand
What is the rationing function
Rising prices to ration the demand for a parody (contract/expand)
Allocative function
Directs resources between markets
Away from firms with excess supply and too high price
Towards markets with excess demand and too low price
When does market failure occur
When the price mechanism performs unsatisfactory or fails to work at all
Complete market failure
Market simply does not exist
Partial market failure
Market functions but produces the wrong quantity of a good or service
Market failure in monopoly
Good too expensive
Underproduction and underconsumption
Define a private good
Excludable and rival
Describe a public good
Non excludable and non rival
Examples of private goods
Chocolate
Phones
Examples of public good
Lighthouse
Radio
Street light
What is the free rider problem
Those that benefit without paying or contributing to an economic exchange
Quasi public goods example
Electronic pricing of road use
Example of quasi oublic good
London roads due to congestion charge
Positive externality
Benefit of production and consumption to third parties
Social benefit > private benefit
Negative externality
Impacts third party through production or consumption
Social cost > private costs
Negative externality examples
Smoking - passive smokers
Alcohol - drunk driving accidents
Positive externality examples
Education - productivity - income - tax - revenue - investment
Social cost equation
Private cost + external costs
What is a merit good
Social benefits of consumption exceed private benefits e.g healthcare
Are merit goods public or private
Private, though often provided by public sector
Value judgements
Decide if a good is merit or demerit
What is a demerit good
Social costs of consumption exceed private costs
Example of demerit good
Tobcco
How do governments try reduce consumption of demerit goods
Taxation
Information problem
Occurs when people make wrong decissions because they do not have correct information
Why monopoly leads to market failure
They limit output and raise prices to max profits
Prices too high and resources allocatively inefficient
How does immobility lead to market failure
Unemployment and waste of scarce resources
Two types of immobility of labour
Geographic
Occupational
Reasons against government intervention
Pro free market economist
Interventionist economists
Explain free market economists
Market mechanism achieves more optimal outcome through incentives by price signals
Explain interventionist economists view on govt intervention
Markets are uncompetitive and monopolistic so prone to market failure
Govt can impose regulations
Two main government intervention
Regulation
Taxation
Regulation
Influences the quantity of the externality a firm can generate
Taxation
Adgjusts the market price higher due to its externality
Example of taxation on negative externalities in production and consumption
Consumption - tax on tobacco to discourage demand
Production - taxing pollution to incentivise factories to produce cleaner
Tax definition
A compulsory levy imposed by the government to pay for its activities
Example of global tax on negative externality
Tradable pollution permits
Negative of maximum prices
Can create excess demand
Negative if minimum prices
Distort markets creating excess supply
Where must minimum. Prices must be set
Above the free market price
Where must maximum prices be set
Below the free market price
Government failure
Occurs when govt intervention reduces economic welfare
Leads to misallocation of resources
what is the classification of a merit/demerit good
value judgement
monopoly market failure
not enough of a good is produced
the price of a good is too high
does not maximise welfare for society
immobile factors of production = market failure
resources are underutilised
inefficiency
govt int - subsidies
increase supply and increased profit revenue
why might min prices be set
to increase wages
make demerit goods more expensive and less desirable e.g. alcohol
min price diagram analysis
will lead to a surplus of supply which the govt buys (subsidies)
issues of min price
costly for the govt to cover the subsidy
a min price encourages famers to increase supply which will cost more than expected on the govt which occured in the EEC CAP
why might max prices be set
if suppliers have monopoly power
the good is socially important
to encourage consumption of merit goods
demand is price elastic because the good is necessary for mainitining good living standards
max price diagram analysis
set below the equilibrium
there will be a shortage and demand is greater than supply
encourages black markets
goods will be rationed
government failure
when the government intervening leads to a loss of economic welfare and misallocation of resources
examples of govt failure
distortion of prices/ free market mechanism
e.g subsidising a failing industry
unintended consequences
excessive administrative costs - social benefits of a policy might not be worth the costs
info gaps - policies require full CBA which is timely
e.g. housing policies are long term and may fail
market mechanism and inequitable distribution of income
likely to lead to higher consumption of demerit goods with neg externalities from lack of govt intervention
govt intervention into inequitable incoem
progressive taxation
govt spending on welfare spending
competition policy aims to ensure
technological innovation and dynamic efficiency
effect price competition between suppliers
four key pillars of competition policy
antitrusts and cartels
market liberalisation
state aid control
merger controls
antitrusts and cartels (comp policy)
elimination of agreements that restrict competition including price fixing and abuse by any firms who hold dominant market position
market liberalisation
introducing competition in previous monopoly industries such as energy supply, retail banking
state aid control (comp policy)
comp policy analyses state made measures such as subsidies to ensure that such measures do not distort the level of competition in the single market
merger control (comp policy)
investigation of mergers and take over between firms
main comp regulator in uk
competition and markets authority
examples of comp policy in action
privatisation- transferring ownership (Stockmarket floatation of Royal Mail)
deregulation - preventing mergers/acquisitions that create monopoly, forced sales of assets e.g. BAA
law enforcement - fines and penalties against price fixing
reducing trade imports- encourages cheaper goods from abroad
allowing new countries into EU single market increases contestibility