Market mechanism, Market failure and Government intervention Flashcards
Price
the value in which a good or service is exchanged
Price mechanism
Changes in demand or supply of a good or service lead to changes in its quantity brought/sold
Name three functions of price mechanism
incentive,signal, ration scarce resources
Incentive
Higher prices encourage all firms to produce more goods
Signaling
changes in price show changes in demand or supply for producers and consumers
Rationing scarce resources
This means when there High demand and supply is limited prices will remain high but if theres low demand and high supply prices will be low
three advantages of price mechanism
Resources will be allocated efficiently to satisfy needs and wants
Consumers decide what is and isnt produced
Price mechanism can operate without the cost of employing people to regulate it
three Disadvantages of price mechanism
Inequality in income and wealth
Under provision of merit goods and over provision of demerit goods
Public goods wont be produced
What is market failure
A misallocation of resources
Types of Market failure
Complete and partial Market failure
Complete market failure
This is when there is a missing market and no market exists
Partial market failure
When the market functions but price or quantity is supplied wrong
Externalities
the effects that producing and consuming has on third parties who werent involved in the producing and consuming of a good or service
Positive externalities and example
external benefit for example improvement in technology
Negative externality and example
External cost for example littering
Private cost
The cost of doing something to ethier a consumer or firm
External cost and example
Caused by externalities for example littering cause council to pay to clean
Social cost
is the total cost bourne to society
Private benefit
the benefit gained by a producer or consumer
External benefit
caused by externalities for example increased equipment means lesser need for electricity
Social benefit
the full benefit recieved for a good or service
MPC
Marginal private cost and its the cost of producing the last unit of a good
MPB
Marginal private benefit the benefit of consuming the last unit of a good
Postive externality diagram
when MPB and MSB are parrallel
Negative externality diagram
When mpc and msc are parallel
Equilibruim
when supply and demand are equal
Socially optimum point
When MSC equals MSB
Socailly optimum level
When output and price gives society maximum benefit of any positive externalities and covers negative externalities
Overproduction for negative externalities
When output is higher than socially optimum level leading to welfare loss
Underconsumption for positive externalities
ignoring potential welfare gain output below socially optimum level
Overconsumption for negative externalities
Ignore negative consumption externalities, consumption higher than socially optimum level causing welfare loss
Under production for positive externalities
ignoring positive positive production externalities resources wont be allocated to socially optimum level
Extended property rights
externalities are accounted for example a water company with property rights can charge people who pollute
Merit goods
Goods whose consumption brings great benefit to society for example education
Why are merit goods underconsumed
Postive externalities ignored
Due to imperfect information consumers dont know full benefit
Demerit Goods
goods whose consumption is regarded as harmful to the people who consume it example is cigarettes
Demerit goods are overconsumed because
negative externalities are ignored
Imperfect information means they arent aware
Value judgement
based on peoples opinions not on economic theory
Government intervention on merit goods
subsidies and taxes
Example of public good
flood defences and street lights
characteristics of public good
Non excludable and non rivalrous
Non excludable
People cannot be stopped from consuming the good even though they havent paid for it
Non rival
a person benefiting from a good doesnt stop others
Private goods
they are exludable and rivalrous an example of this is biscuit
Quasi public goods
Goods that exbhit the characteristics of a public good but not really
example of quasi Public goods
roads because they are non excludable which means they are free to use and non rival which means one use doesnt deny someone elses but they can be excludable due to tolls and rival due to congestion
free rider problem and example
once a public good is provided its impossible to stop someone from benefiting for example providing street cleaning cannot stop a free rider who refuses to pay for street cleaning
tragedy of the commons
the idea that people acting in their best interest will overuse a common resource without considering that it will lead to the depletion and degradation of the resource
Income
The amount of money recieved over a set period of time
Wealth
the value of assets held
Causes of inequality
wage differientials,discrimination, regressive tax
impact of inequality
lack of education, lack of access to vital resources, market failure due to an unequal distribution of income
Government intervention on inequality
value judgements through political decisions
benefits to redistribute income
state provision like health and education
progressive tax to higher incomes
economic growth bringing more jobs and higher wages
national minimum wage to reduce poverty for lower incomes
pure monopoly
this is when there is only one supplier in the market
Monopoly power
The ability to influence the price of a good
How is market failure caused by a monopoly
if theres one firm in the market it could misallocate resources restricting supply and price
Example of state provision
NHS, education, fire, police services
How does state provision solve market failure
Increases consumption for merit goods
help to reduce inequalities
help redistribute income
Disadvantages of state provision
Less incentive to operate efficiently
fail to respond to consumer demands
opportunity cost compared to producing other goods
Regulation
rules inforced by authority
Legislation
Legal action taken by anyone who breaks the rules
Regulation solving market failure
reduced demerit goods through banning
reduced monopoly power through price caps
disadvantages of regulation
level of regulation difficult to assess
Regulation is expensive forcing firms to to move country
Government failure
An unintended consequence to correct market failure by leading resources to be misallocated and welfare loss
Red tape
The government having lots of rules and regulations
Government interventions creating market distortions
Income tax is a disincentive to work hard
subsidies dont encourage firms to be efficient
Government price fixing like minimum and maximum pricing can disort price signals
Government Conflicting objectives causing market failure
Government effort to achieve a certian objective has a negative impact on the other
for example the policy of tighter emission control help to achieve enviromental objectives but will increase costs and output reducing economic growth
How can administrative costs cause government failure
regulation and policies result in higher costs due to large resources
policing could be expensive
Competition Policy
To protect the interest of consumers by promoting competition and encouraging markets to function efficient
CMA
Competition markets authority to look out for unfair monopolistic behaviour
what issues does the CMA need to monitor-Mergers
monitor mergers and takeovers so they prevent those that arent beneficial to the effiency of the market to consumer
what issues does the CMA need to monitor-Agreements between firms
agreements involve price fixing, spliting markets or limiting production which is anti competitive
what issues does the CMA need to monitor-financial support
if a government in one EU country gives financial support to firms in the market
How can the Government bring intervention to bring more competition
Privatisation and Regulation
How can privatisation bring competition-advantages and disadvantages
Privitisation can introduce competition by removing public monopoly
Privatisation could turn a public monopoly to private monopoly
Privatisation could increase prices and reduce output
How can regulation bring competition
Can control monopoly power through price caps
regulation to improve quality standards
windfall taxes to reduce monopoly power
absence of property of rights
causes production and consumption externalities, market failure also a missuse of scarce resources
an example is a factory emiting into a nearby river wouldnt be accounted for
disadvantages for extending property rights
externalities could affect more than one country- it will be hard to account for them
could be difficult to extend property rights
high cost of suing people who infringe property rights
