Market Mechanism, Market Failure and Government Intervention in Markets

Question 1

Define market failure

Answer 1

• Market failure occurs when there is an inefficient allocation of resources within a market. The pricing mechanism leads to a failure in allocating scarce resources efficiently.
• Pricing mechanism leads to a net social welfare loss, social welfare not maximised.

Question 2

Difference between complete and partial market failure

Answer 2

• Complete market failure occurs when there is a ‘missing market’ when no goods/services are provided within this market (lack of incentives?).
• Partial market failure occurs when a market produces an ineffective level of output/price, therefore a misallocation or resources has occurred (meaning resources can be used more efficiently).

Question 3

Describe examples of market failure

Answer 3

• Negative externalities which leads to the social cost burdened onto society exceeding the social benefit leading to a net welfare loss.
• Missing markets leading to markets not existing to satisfy consumer needs.
• imperfect information
• Under provision of public and merit goods, leading to societies optimum level of social benefit not being achieved.
• Market dominance leading to potential exploitation of consumers and reduced quality of goods.
• Markets causing inequality and reduced equity.

Question 4

Describe public goods + examples

Answer 4

• A public good is a good which are non-rival and non-excludable, with the supply of public goods being a missing market (complete market failure).
• If the supply of public goods was left to the free market, supply would cease to exist/minimal supply.
• Street lights, flood barriers, national defence, law enforcement.

Question 5

Describe the characteristics of public goods

Answer 5

Public goods are:

• Non-Rival meaning if a consumer consumers one unit of this particular good, it would not reduce the amount available to others.
• Non-Excludable meaning once a public good has been provided nobody can be specifically excluded from consuming this good. Cannot enforce property rights on a public good.

Question 6

Describe private goods

Answer 6

• Private goods are goods which are both excludable and rivalrous. Private goods are provided by the private sector as there is an incentive of profit due to their characteristics.
• Individuals can be excluded from consuming private goods through enforceable property rights.

Question 7

Describe quasi goods

Answer 7

• Quasi goods are goods that have characteristics of both private and public goods.
• Quasi goods can be seen as public goods which are provided by the private sector due to profit incentive from government subsidies/contracts etc.
• Eg) Roads

Question 8

Describe the free rider problem

Answer 8

• The characteristics of public goods lead to the free rider problem occurring.
• The free rider problem occurs once a public good has been provided and there becomes no incentive for individuals to contribute towards the cost (pay) as they can consume the good without paying.
• Individuals can consume and experience the benefits of a public good without paying for it.

Question 9

Benefits and costs of government provision of public goods

Answer 9

Benefits:

• Improving living standards –> long term economic growth
• Equity, if gov provided public goods this allows all individuals regardless of income/wealth to have access to public goods, rather than supply based on ability to pay.

Costs:

• Opp cost
• Debt/funding (increase in deficit)
• Potential future tax increases which may have long term economic growth (AD)
• May lead to gov failure (poor quality goods)
• Maintenance costs
• Difficult to determine the amount that should be provided.
• Difficult to determine the overall social benefit and whether the provision is necessary or not.

Question 10

Describe the tragedy of the commons

Answer 10

• An economic problem in which individuals favour personal gain at the expense of other individuals/society.
• Leads to the overconsumption and depletion of a common resource.
• For the tragedy of the commons to occur a resource/good must be scarce, rivalrous and non-excludable.

Question 11

Describe examples of market failure within the labour market.

Answer 11

• Discrimination of specific individuals leading to an inequitable outcome.
• Monopsony, monopsony power leads to wages being driven down.
• Geographical imobilites factors which make it difficult to move between geographical lcoations for work.
• Occupational imobilities, factros which influence how easy it is to move between different jobs (influenced by skillset of labour itself).
• Unemployment trap leads to no incentive to find work/start business as less money would be earned than on benefits for example.

Question 12

Describe how a lack of property rights may cause negative extrenaliteis

Answer 12

• With a lack of property rights, some goods/resources are unaccounted for therefore this means individuals have unlimited access to these goods/resources and can exploit their use.
• EG) A factory dumps its waste in a river in which no one had property rights over.

Question 13

Describe positive externalities + examples

Answer 13

• Positive externalities, usually caused by a merit good, refers to the external benefits/spill over benefit to a third party caused by the consumption or production of a good/service.
• Eg) Healthcare, better education system, vaccinations and

Question 14

Describe negative externalities + examples

Answer 14

• Negative externalities, usually caused by a de-merit good, refers to the external costs/spill over costs to a third party caused by the consumption or production of a good/service.
• EG) Smoking, crime, littering, alcohol

Question 15

Describe merit goods + why underproduced/consumed

Answer 15

-Merit goods are goods that are seen to be beneficial for society when produced and consumed as the consumption/production of these goods lead to positive externalities (Goods with positive externalities).

Underproduced/consumed:

• Lack of information as consumers and producers are usually unaware of social benefits/costs.
• Social benefit/social cost is ignored by firms and consumers.

Question 16

Describe merit goods + why underproduced/consumed + example

Answer 16

-Merit goods are goods that are seen to be beneficial for society when produced and consumed as the consumption/production of these goods lead to positive externalities (Goods with positive externalities).

Underproduced/consumed:

• Lack of information as consumers and producers are usually unaware of social benefits/costs.
• Social benefit is ignored by firms and consumers.

Question 17

Describe de-merit goods

Answer 17

-De Merit goods are goods in which have a greater social cost than private cost and are seen as detrimental to society as the production/consumption of de-merit goods cause negative externalities.

Overproduced/consumed:

• Lack of information
• Social costs are ignored by firms and consumers.

Question 18

Describe government policies to combat market failure

Answer 18

• Indirect taxes and higher taxes on business profits for firms producing demerit goods will lead to an overall increase in the cost of production, therefore a fall of in supply/increase in price.
• Business subsidies can be paid to firms producing merit goods to reduce production costs and increase output to attempt to achieve the socially optimum equilibrium.
• Maximum price below the equilibrium price may be implemented to prevent price exploitation.
• Minimum price above the market equilibrium price to discourage production of a good/service, leading to a potential eduction in negative externalities.
• Gov provision of merit and public goods.
• Better access/provision of information to reduce information failure.
• Stricter regulation
• Competition policies to combat monopoly/oligopoly power. Such as lowering barriers to entry, subsidising medium sized firms and government contract markets encourage reduced costs/improved quality.

Question 19

Describe government failure

Answer 19

• Gov failure occurs when the government attempts to correct market failure by intervening in a specific market and this intervention leads to a worse off allocation of resources than previously.
• Government intervention leads to a further reduction in the welfare of society.
• Intervention is ‘ineffective, inefficient, inequitable’
• Law of unintended consequences explains potential impacts of market failure.

Question 20

Describe potential causes of government failure

Answer 20

• Not allowing the free market price mechanism to allocate resources could be seen as government failure, as government intervention has led to disequilibrium/miss-allocation of resources.
• Potential unintended consequences which lead to further market failure. Gov unsure to what the outcome of intervention may be.
• Cost of provision may exceed the social benefit of intervening within a market
• Information failure/gaps in information may lead to ineffective intervention/policies due to a lack of through due diligence. Potential rushed policies.
• Intervention leading to a larger impact on poorer individuals –> increase in economic inequality.

Question 21

Describe examples of government failure

Answer 21

• Landfill site taxes may lead to individuals illegally dumping waste in non-registered areas leading to further pollution and waste issues (fly-tipping).
• Minimum price imposed on alcohol may lead to the creation of blackmarkets, increase in smuggling potential rise in the use of cheaper drug alternatives.
• The contracting of the construction of gov housing to the private sector may lead to ‘corner cutting’ and reduced quality (safety issue) as firms in the private sector profit maximise and are incentivised to reduce costs wherever possible. EG) Grenfell disaster.
• Bank bail outs may lead to banks acting in moral hazard, a situation where an entity increases its risk tolerance as they do not bear the potential consequences/costs.