micro 2.8- market failure Flashcards
define market failure
Market failure is a failure of the free market to allocate resources efficiently. Allocative efficiency isn’t achieved and there is over or under allocation of resources.
what is an externality and when does it occur ?
a type of market failure that occurs when the consumption or production of a good or service, harms or benefits a third party
define a merit good
goods that create positive consumption externalities and benefit those who consume them
give and explain a positive consumption externality
‘consuming’ healthcare:
- their own health is better
- will not pass illnesses to others
define a positive consumption externality
when consumption of a good or service benefits a third party who does not pay for it
define a negative consumption externality
when the consumption of a good or service harms a third party and the third party isn’t compensated
give and explain an example of a negative consumption externality
Cigarette and smoking -> higher NHS costs
- Taxpayers having to pay for health treatment
- Passive smoking from someone else
what are demerit goods?
goods that create negative consumption externalities and harm the consumers who consume them
MSC
Marginal social cost (MSC) is the total cost society incurs from producing the next unit of the good.
MPC
Marginal private cost (MPC) is the cost a firm incurs from producing the next unit of the good
MSB
Marginal social benefit (MSB) is the benefit that society gains from the consumption of an additional unit of a good
MPB
Marginal private benefit is the benefit that an individual gains from the consumption of an additional unit of a good
when does allocative efficiency occur?
when there is a socially optimum output; MSB=MSC and social/community surplus is maximised
where does actual market equilibrium occur?
at MPB=MSC
draw a labelled diagram for a negative consumption externality
elsewhere
define welfare loss
the lost welfare as a result of too much or too little production and consumption of a good or resource
why do governments keep demerit goods?
- tax revenue
- industry creates jobs
give 6 ways that governments try to reduce negative consumption externalities (eg smoking)
Regulations (eg bans/age restrictions)
Indirect taxes
Nudges
Pmin
Negative advertising
Importing a certain amount
explain how regulations/laws help reduce negative consumption externalities
demand decreases, so MPB falls
evaluate restrictions/laws as a method to reduce NCE
cons:
- unemployment might increase in the specific sector
- loss of government revenues from taxes
- smokers in the SR will be worse-off as they will enjoy less of the good
- need to monitor that laws are followed or else they will be broken
pros:
- but in the LR they will be better-off if their health improves
- non-smokers will be better off as the externality will decrease
explain how indirect taxes help reduce NCEs
supply decreases; MSC shifts to the left and quantity of the good moves closer to socially efficient level of output
evaluate indirect taxes as a method to reduce NCEs
- tax is regressive so poorer groups are worse-off
- Qd will not fall significantly if PED is inelastic
- difficult to accurately measure externality and thus correct it (you might over or under shoot). So difficult to set the tax at the right level to internalise the external costs.
define a pigouvian tax
an indirect tax that is imposed on any market that creates negative externalities, in order to eliminate the externality
explain negative advertisement/education as a method to reduce NCEs
demand decreases; MPB falls
evaluate negative advertisement/education as a method to reduce NCEs
- unemployment might increase in the specific sector
- loss of government revenues from taxes
- smokers might find it hard to quit
- non-smokers will be better off as the externality will decrease
congestion charge as an eg of decreasing NCEs
the effectiveness depends on how close or weak substitutes drivers think cars and public transportation are. Public transportation is usually less comfortable and takes longer
(-) Domestic businesses might see a decrease in their customers if it is harder for them to access the city centre and there are no other substitutes. Consumers might switch to online shopping.
(-) higher income groups will not be significantly affected as it is a small percentage of their income
(+) part of the externality is internalised
alternating license plates as an eg of decreasing NCEs
- households may buy 2 cars with different licence plates to be able to enter the city centre
- domestic businesses might see a decrease in their customers if it is harder for them to access the city centre and there are no other substitutes.
- Consumers might switch to online shopping.
define a positive consumption externality
when the production of a good or service benefits a third party
give 3 ways in which positive consumption externalities can be boosted
- subsidies
- legislation/regulation
- positive advertising
draw a diagram for negative consumption externality
elsewhere
give 3 ways in which negative production externalities can be reduced
- legislation & regulation
- carbon taxes
- tradable pollution permits
explain legislation and regulation as a method of reducing NPEs
supply decreases; MPC decreases and shifts to the left
define MPC
marginal private cost; the change in the producer’s total cost brought about by the production of an additional unit of a good or service.
evaluate legislation and regulation as a method of reducing NPEs
pros:
- cost of production might increase if firms need to pay to have their waste burnt or if they need to buy filters -> maybe higher prices for consumers
- less pollution -> sustainable growth
cons:
- need to monitor that laws are followed or else they will be broken
- high administrative costs to regulate all industries
- fines should be high in order to deter firms from breaking the law
- higher unemployment in specific industries
- firms might relocate to countries with more relaxed laws
- Regulatory capture
explain carbon taxes as a method of reducing NPEs
cost of production increases -> supply decreases; MPC decreases and shifts to the left
evaluate carbon taxes as a method of reducing NPEs
- cost of production will increase -> maybe higher prices for consumers
- producers might switch to “green” technologies in order to avoid carbon taxes
- less pollution -> sustainable growth
- more government revenues
- domestic firms might shut down if consumers import from abroad from countries with weaker environmental regulations
- difficult to accurately measure externality so usually tax doesn’t equal the externality (over or under shoot). If tax equaled externality then it would be internalised.
- higher unemployment in specific industries
- externality is internalised
is internalising an externality a good or bad thing?
Internalising externalities helps to create a more efficient and equitable allocation of resources by ensuring that the costs and benefits of economic activities are reflected in the prices paid by the participants, rather than being imposed on third parties.
explain tradable permits/cap and trade scheme as a method of reducing NPEs
supply falls; MPC decreases and shifts left
evaluate tradable permits/cap and trade scheme as a method of reducing NPEs
- cost of production will increase -> maybe higher prices for consumers
- difficult to set acceptable pollution level & measure how much each firm is polluting
- less pollution -> sustainable growth
- need to monitor that laws are followed or else they will be broken
- higher unemployment in specific industries
- externality is internalised
- Firms may relocate to other countries with more relaxed laws
- administrative costs to the government
give an example of tradable permits
EU Emissions Trading System (ETS)
- The permits for greenhouse gas emissions are distributed between the EU member countries
- Then each EU country distributes the permits to the firms
- Firms can trade permits. If they exceed their allowance then they will be fined if they are caught
- In order to help reduce pollution, each year the number of permits decreases in order for firms to strive to lower their emissions
draw a diagram for the EU trading system
elsewhere
ETS Main Disadvantage
The price per permit is very low because initially the EU issued many permits
state 2 policies to address pollution
subsidise cleaner firms and international agreements
why are international agreements required?
pollution is a global problem
explain how subsidising green firms helps reduce pollution
cost of production decreases-> supply increases for “greener” firms
evaluate subsidising green firms as a way to reduce pollution
- cost to the government
- subsidies should be given to such an extent that it is cheaper for the firms to use cleaner energy (e.g. solar power) instead of buying fossil fuels (substitutes)
- fossil fuel producers will be worse off but renewable energy producers will be better off
- less pollution -> sustainable growth
- higher unemployment in specific industries
- renewable energy (e.g. wind farms) may create visual and noise pollution and decrease property prices
give an example of international agreements as a way to help reduce pollution
e.g. KYOTO protocol (goal: reduce greenhouse gases), Paris agreement and SDGs
give 4 problems of using fossil fuels as energy sources
Demand for fossil fuels has increased (depleted)
When fossil fuels are burned, GHG are emitted into the atmosphere (a CAR) -> climate change: floods, extreme weather
Furthermore, sometimes when they are extracted oil spills occur which damage the area, the local communities and lead to many animals dying.
Their extraction & use generate external costs that threaten the future generations’ access to them (Negative production externalities)
how is sustainability threatened by LDCs?
LDCs rely primarily on agricultural goods or commodities for income-> pressure on land resources for subsistence purposes and for more intensive cultivation to support their livelihood-> deforestation and soil erosion
how do more developed countries exacerbate LDCs’ threat to sustainability?
LDCs often have debts
They are pressured by the IMF or the World Bank to increase export revenue and facilitate foreign direct investment (FDI) to repay their debts
Result: pollution and depletion of natural resources -> unsustainable growth in LDCs
give 2 characteristics of common access resources
Non-excludable- everyone can use it
Rivalrous- when one person uses it, this diminishes the utility for someone else
what is the problem with CARs?
over-used -> depleted-> Threat to sustainability:
Tragedy of the commons- Individuals benefit from exploiting the resource but the cost of exploitation is shared amongst everyone
define sustainable development
Sustainable development is the development that meets present needs without compromising the ability of future generations to meet their own needs.
give 6 examples of CARs
Common fishing grounds
Sheep grazing a pasture
Black rhinos
Forests
Oceans
Atmosphere
give 4 reasons why CARs are exploited
lack of price
lack of ownership
high poverty & pursuit of economic growth (mainly LDCs)
lack of regulations
6 ways in which governments try reduce exploitation of common access resources
Legislation (e.g. fishing seasons)
Tradable Permits (e.g. 10 fish/day)
- The EU fish quotas might be set at a high level because depletion of fish stocks continues
- Fishing boats throw back smaller dead fish in order to catch bigger ones and meet their quota
Fence areas (conservation areas)
Assign property rights
Privatize communal areas
Education
evaluate assigning property rights as a way to try and reduce exploitation of common access resources
(+) The negative externalities created can now be accounted for (e.g. individuals with property rights over a lake can sue companies that pollute the river)
(-) Individuals may not sue companies as it is very expensive and may take many years
(-) It may be difficult to determine the polluter in some cases (e.g. if a river is very long and there are many firms set near that river- Thames)
give the main strengths and limitations of govt policies to correct externalities and approaches to managing common pool resources
- challenges involved in the measurement of externalities
- degree of effectiveness
- consequences for stakeholders
pros and cons of international cooperation
- global nature of sustainability issues
- challenges faced in international cooperation
- monitoring and enforcement
Define positive production externalities
When the production of a good or service benefits a third party and the third party doesn’t pay for it
give an example of a positive production externality
firms producing using green technology and less harm to the environment, thus sustainable growth
draw a diagram for a positive production externality
underproduction of merit good as MPC, S < MSC
give 3 ways that govt could increase positive production externalities
Laws & fines (ie making it mandatory to do something)
subsidies (increase supply)
taxes (increase supply)
pros and cons of laws & fines as a way to increase positive production externalities
(-) cost of production might increase-> maybe higher prices for consumers (poorer consumers will be severely affected if the price of necessities increases)
eg for greener production technologies:
(+) less pollution -> sustainable growth
(-) need to monitor that laws are followed or else they will be broken
(-) fines should be high in order to make the firms adhere to the laws
pros and cons of subsidies as a way to increase positive production externalities
(-) higher cost to the government ->maybe higher future taxes
(-) opportunity cost -> less spending on other areas
eg (+) less pollution -> sustainable growth (in this case)
(-) difficult to accurately measure externality so usually subsidy doesn’t equal the externality (over or under shoot).
(-) higher unemployment in industries that aren’t subsidised
eg (-) subsidies should be given to such an extent that it is cheaper for the firms to use cleaner energy (e.g. solar power) instead of buying fossil fuels (substitutes)
pros and cons of taxes as a way to increase positive production externalities
(-) less tax revenues to the government
eg (+) less pollution -> sustainable growth (in this case)
(-) difficult to accurately measure externality so usually subsidy doesn’t equal the externality (over or under shoot).
(-) higher unemployment in industries that don’t use that technology
Define a public good
goods that are non-excludable and non-rivalrous
Why would public goods not be provided at all in a free market?
Due to the free rider problem- This occurs when people can benefit from a good/service without paying anything towards it.
what does non-excludable mean?
it is costly or impossible for one user to exclude others from using a good
when one person uses it, this diminishes the utility for someone else
3 types of goods:
- pure public
- quasi public
- private
- Pure public goods: goods that are non-excludable and non-rivalrous
- Quasi public goods: goods that are either non-excludable or non-rivalrous (e.g. roads with tolls)
- Private goods: goods that are excludable and rivalrous (e.g. diet coke)
Policies to overcome the lack of public goods in the free market
direct govt provision or public-private partnerships
