Market Mechanism, Market Failure, Gov intervention

Question 1

The Price Mechanism

Answer 1

• the rationing function
• the signalling function
• the incentive function
• the allocative function

Question 2

The RAtioning FUnction

Answer 2

• as prices rise, removes excess demand, only consumers with ability to pay can purchase goods

Question 3

The Signalling Function

Answer 3

-prices provide important information to market participants i.e increase or decrease production

Question 4

The Incentive function

Answer 4

increased prices strengthen incentive for firms to produce more

Question 5

The Allocative function

Answer 5

the function of prices that acts to divert resources to where returns can be maximised

Question 6

Market failure

Answer 6

when the free market leads to a misallocation of resources in an economy

Question 7

complete market failure

Answer 7

ie missing market

when free market fails to create market for particular goods and services

Question 8

public goods

Answer 8

goods that are non rival and non excludable in consumption

Question 9

non excludable

Answer 9

can’t prevent non paying consumers from consumin

Question 10

non rival

Answer 10

one persons enjoyment of a good does not diminish anothers enjoyment

Question 11

the free rider problem

Answer 11

individual consumers hope to get a ‘free ride’ without paying for the benefit they enjoy
- public goods = complete market failure- free markets no incentive to provide

Question 12

private goods

Answer 12

a good that is rival and excludable in consumption

Question 13

quasi- public goods

Answer 13

a good that exhibits not all but some characteristics of a public good

Question 14

externalities

Answer 14

third party affects arising from the consumption and production of goods and services

Question 15

MSC

Answer 15

Marginal private costs + marginal external costs

Question 16

MSB

Answer 16

marginal private benefit + marginal external benefit

Question 17

when is social welfare optimises

Answer 17

when MSB = MSC

Question 18

Positive Externalities in Production

Answer 18

1) MPC > MSC therefore negative marginal external costs
2) free market equilibrium: MPB = MPC
3) socially optimal equilibrium: MSB = MSC
4) welfare gain to society as MSB > MSC at fm eq as FM doesn’t account for external benefits
5) underproduction

Question 19

Positive Externalities in Consumption

Answer 19

1) MSB > MPB therefore marginal external benefit
2) free market equilibirum: MPB = MPC
3) socially optimal equilibrium: MSB = MSC
4) welfare gain to society as MSB > MSC at fm eq as fm doesnt account for external benefits
5) underconsumption

Question 20

Negative Externalities in Production

Answer 20

1) MSC > MPC therefore marginal external cost
2) Free market equilibrium: MPB = MPC
3) socially optimal equilibrium: MSC = MSB
4) welfare loss to society as MSC > MSB at fm eq as fm doesnt account for external costs
5) overproduction

Question 21

Negative Externalities in Consumption

Answer 21

1) MPB > MSB therefore negative marginal external benefit
2) Free market equilbrium: MPB = MPC
3) socially optimal equilibirum: MSC > MSB at fm eq as fm doesnt account for external costs
4) overconsumption

Question 22

tragedy of the commons

Answer 22

the overuse of natural resources such as oceans, forests or atmospheres
- can be analysed using negative externality diagrams

Question 23

merit goods

Answer 23

a good that would be underconsumed in a free market

Question 24

Why are merit goods under consumed?

Answer 24

1) Information failure- people unaware of the potential private benefits from consuming merit goods in the long run
2) expensive
3) society may not take into account the wider benefits to society of their use of merit goods

Question 25

demerit goods

Answer 25

a good that would be overconsumed in a free market

Question 26

why are demerit overconsumed

Answer 26

1) information failure- people unaware of the damage to their health
2) cheap
3) society doesnt take into account wider external cost

Question 27

Market imperfections

Answer 27

• imperfect information
• monopoly
• immbolility of fOp
• occupational immobility
• geographical immobility

Question 28

occupational immobility

Answer 28

difficult to move jobs due to lack of skills

Question 29

geographical immbolity

Answer 29

difficult moving to locations where jobs available

Question 30

government intervention

Answer 30

action taken by government that seeks to change the decisions made by individuals, groups and organisations about social and economic matters.

Question 31

reasons for gov intervention

Answer 31

• correct market failure
• achieve fairer distribution of income and wealth
• achieve gov macro objectives

Question 32

indirect tax

Answer 32

• tax on spending, sometimes used to reduce consumption

Question 33

unit taxes

Answer 33

fixed amount added per unit

Question 34

ad valorem

Answer 34

adding a percentage of the price of a good eg vat

Question 35

advantages of indirect tax

Answer 35

1) strong tax revenue, gov can spend on healthcare
2) use of price mechanism, consumers and producers decide how to adjust behaviour
3) helps internalise external costs

Question 36

disadvantages of indirect tax

Answer 36

1) if placed on inelastic goods, demand may not fall unless large tax
2) difficult to place accurate monetary value on external costs
3) tends to be regressive- larger percentage of poorer persons income

Question 37

subsidies

Answer 37

payment made to producers to encourage increased production of a good or service

Question 38

Advantages of subsidies

Answer 38

1) increase consumption of merit goods, internalise external benefit
2) reduce price of goods, more affordable for those on lower incomes

Question 39

Disadvantages of subsidies

Answer 39

1) opportunity cost
2) firms may become reliant- encourages productive inefficiency, reduces international competitiveness lr
3) little impact on inelastic goods

Question 40

minimum prices

Answer 40

a price floor placed above free market equilibirum

Question 41

Advantages of minimum price

Answer 41

1) gives producers guaranteed income (raise living standards)
2) encourage production of essential products

Question 42

Disadvantages of minimum price

Answer 42

1) consumers pay higher price, reduce disposable income
2) reduce international competitiveness if price raised above foreign competitors
3) may encourage people to seek cheaper, more harmful alternatives

Question 43

Maximum prices

Answer 43

a price ceiling above which prices are not permitted to rise

Question 44

Advantages of maximum prices

Answer 44

1) without, people may not be able to afford certain goods

2) reduce ability of firms with monopoly power to exploit

Question 45

Disadvantages of maximum prices

Answer 45

1) creation of excess demand implies queues shortages waiting list
2) may lead to the establishment of black markets

Question 46

government failure

Answer 46

when government intervention in a market reduces overall economic welfare

Question 47

Reasons for government failure

Answer 47

1) inadequate information
2) unintended consequences
3) market distortions
4) administrative costs

Question 48

inadequate information

Answer 48

• difficult in practice to place an accurate monetary value on external costs and benefits
• therefore unlikely to completely internalize externalities and lead to social optimum or allocative efficiency

Question 49

administrative costs

Answer 49

costs of researching and implementing any intervention may outweigh the benefit of the policy itself

Question 50

Competition Policy

Answer 50

government policy that aims to make markets more competitve

Question 51

Competition Policy focuses on four areas

Answer 51

1) monopolies
2) mergers
3) restrictive trading practices
4) promoting competition

Question 52

Methods to tackle monopolies;

Answer 52

1) Windfall taxes on snp
2) Maximum prices
3) deregulation = removing B2E = more contestable

Question 53

mergers

Answer 53

when two or more firms willingly join together

Question 54

Public ownership

Answer 54

government ownership of firms, industries or other assets

Question 55

Nationalisation

Answer 55

the transfer of assets from the private sector to public ownership

Question 56

Advantages of public ownership

Answer 56

1) more likely to take into account externalities not profit maximising
2) social welfare = allocatively efficient

Question 57

Disadvantages of public ownership

Answer 57

1) Lack of dynamic efficiency = lack of pressure to maximise profits, absence of competition
2) Lack of expertise= could be argued best managers found in private sector, where financial rewards could be higher than public

Question 58

Advantages of privatisation

Answer 58

1) Raising extra rev for gov = sale of state owned assets to private sector can generate significant short term revenue
2) promoting competition
3) promoting efficiency - profit motive cut costs

Question 59

Disadvantages of privatisation

Answer 59

1) Exploitation of monopoly power
2) Short termism = pressure from shareholders who demand annual dividends = focus on profit maximising cutting costs rather than long term investment projects
3) ignoring externalities

Question 60

privatisation

Answer 60

sale of government owned assets to the private sector