Market mechanism, Market failure and government intervention in markets

Question 1

Market mechanism

Answer 1

the process through which changes in prices allocate resources

Question 2

Price mechanism

Answer 2

changes in price in response to changes in demand and supply have the effect of making demand equal to supply

Question 3

Functions of the price mechanism

Answer 3

• Allocative
• rationing
• incentive
• signalling

Question 4

Allocative function of price

Answer 4

changing relative prices allocate scarce resources away from markets exhibiting excess supply and into markets in which there is excess demand.

Question 5

Deadweight loss

Answer 5

the loss of welfare when the maximum attainable level of total welfare is not achieved. surplus has been lost from one party without being transferred to the other

Question 6

Market failure

Answer 6

occurs when the price mechanism fails to allocate scarce resources in a productively efficient way and when the operation of market forces leads to an allocatively inefficient outcome

Question 7

Partial market failure

Answer 7

a market does function, but it delivers the ‘wrong’ quantity of a good or service, which results in resource misallocation

Question 8

Productive efficiency

Answer 8

The production of a good in the least costly way; occurs when production takes place at the output at which average total cost is a minimum

Question 9

Market

Answer 9

anywhere where buyers and sellers come together, a price is agreed and a transaction takes place

Question 10

Shortage

Answer 10

excess demand in a market which is in disequilibrium

Question 11

Surplus

Answer 11

excess supply in a market which is in disequilibrium

Question 12

Equilibrium price

Answer 12

price where quantity supplied equals quantity demanded; at this price there is no shortage or surplus

Question 13

Shadow market

Answer 13

anywhere where buyers and sellers come together, a price is agreed and an illegal transaction takes place

Question 14

Minimum price (price floor)

Answer 14

a legal limit on how low a price can be charged for a particular good, in a particular market

Question 15

Effects of minimum price below equilibrium

Answer 15

no effect on price or quantity sold

Question 16

Effects of minimum price above equilibrium

Answer 16

Price increase therefore excess supply

Question 17

Tragedy of the commons

Answer 17

an economic problem in which every individual tries to reap the greatest benefit from a given resource. As the good is rivalrous, every individual who consumes an additional unit directly harms others who can no longer enjoy the benefits

Question 18

Information gap

Answer 18

the difference between the perceived and true values of a cost, benefit or price

Question 19

Progressive taxation

Answer 19

a tax for which, as income rises, a greater proportion of income is paid

Question 20

Means tested benefits

Answer 20

benefits claimable depending on the person’s income

Question 21

Complete market failure

Answer 21

the absence of a market for a good or a service

Question 22

5 forms of government failure

Answer 22

• regulatory capture
• imperfect information
• conflicting objectives
• administration costs
• unintended consequences