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Edexcel A Economics Themes 1 and 2 > Micro 9 - Introduction to Market Failure and Externalitites > Flashcards

Micro 9 - Introduction to Market Failure and Externalitites Flashcards

1
Q

What are the 3 causes of market failure?

A
  • Externalities
  • Under-provision of public goods
  • Information gaps
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2
Q

When does market failure occur?

A

A market fails when the price mechanism (the forces of supply and demand) fails to allocate scarce resources efficiently and society suffers as a result

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3
Q

How commonly does market failure occur?

A

Market failure is a common problem and governments often intervene to try and prevent it

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4
Q

What are externalities?

A

Externalities are the effects that producing or consuming a good or service has on people who aren’t involved in the making, buying, selling and consumption of the good or service. These people are called third parties

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5
Q

Who do externalities affect?

A

Third Parties

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6
Q

What are the two types of externalities?

A

Positive or negative

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7
Q

What are positive externalities?

A

Positive externalities are the external benefits to a third party

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8
Q

What are negative externalities?

A

Negative externalities are the external costs to a third party

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9
Q

What two things can externalities occur in?

A

Production or consumption

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10
Q

Give an example of a negative externality in production

A

A negative externality of producing steel could be the pollution that harms the local environment

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11
Q

Give an example of a positive externality in consumption

A

A positive externality of someone training to become a doctor could be the benefit to society that this brings

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12
Q

How do externalities cause market failure?

A

Market failure occurs because externalities are ignored

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13
Q

Define the term private cost

A

A private cost is the cost of doing something to either a consumer or a firm

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14
Q

Define the term external cost

A

External costs are the costs imposed on a third party as a result of the decisions made by others to produce or consume a product

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15
Q

How do you calculate social cost?

A
  • Adding the private cost to the external cost gives the social cost
  • Social cost = Private cost + External cost
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16
Q

Define the term private benefit

A

A private benefit is the benefit gained by a consumer or a firm by doing something

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17
Q

Define the term external benefit

A

External benefits are the benefits that are experienced by third parties as a result of decisions made by others to consume or produce a product

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18
Q

How do you calculate social benefit?

A
  • Adding the private benefit to the external benefit gives the social benefit
  • Social benefit = Private benefit + External benefit
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19
Q

Define the term social benefit

A

The social benefit is the full benefit received by society from a good or service

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20
Q

Define the term social cost

A

The social cost is the full cost borne by society of a good or service

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21
Q

Why does market failure occur in the free market?

A

Market failure occurs because in a free market the price mechanism will only take into account the private costs and benefits but not the external costs and benefits

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22
Q

Do negative externalities occur in production or consumption?

A

Production

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23
Q

What do negative externalities occur in?

A

Production

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24
Q

What is the marginal private cost?

A

The marginal private cost (MPC) is the cost of producing the last unit of a good

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25
Q

How do you calculate the marginal social cost?

A

Marginal social cost = Marginal private cost + External cost

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26
Q

On a diagram what is the difference between the MPC and MSC curves?

A

The difference between the MPC and MSC curves is the external cost of production which is the negative externalities

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27
Q

What does it mean if the MPC and MSC curves are parallel?

A

The external costs per unit produced are constant

28
Q

What does it mean if the MPC and MSC curves diverge?

A

The external costs per unit increase with output

29
Q

Give an example of why the MPC and MSC curves might diverge

A

The curves might diverge due to pollution - the external costs per unit created pollution can increase as the output increases

30
Q

Do positive externalities occur in production or consumption?

A

Consumption

31
Q

What do positive externalities occur in?

A

Consumption

32
Q

What is the Marginal private benefit?

A

The marginal private benefit is the benefit to someone of consuming the last unit of a good

33
Q

How do you calculate marginal social benefit?

A

Marginal social benefit = Marginal private benefit + External benefit

34
Q

What is the difference between the MPB and MSB curves?

A

The difference between the MPB and MSB curves are the external benefits which are the positive externalities

35
Q

What does it mean if the MPB and MSB curves are parallel?

A

The external benefits per unit are constant

36
Q

What does it mean if the MPB and MSB curves diverge?

A

The external benefits per unit increase with output

37
Q

Give an example of why the MPB and MSB curves diverge

A

An example of when the curves might diverge is vaccination - the more people that are vaccinated the greater the protection for unvaccinated people

38
Q

What is the general relationship between the equilibrium point and the socially optimal point?

A

The equilibrium point may be different to the socially optimal point

39
Q

When does equilibrium occur in the free market?

A

When supply equals demand

40
Q

On a diagram can the MPC curve be seen as a supply curve or a demand curve?

A

Supply curve

41
Q

On a diagram can the MPB curve be seen as a supply curve or a demand curve?

A

Demand curve

42
Q

On a diagram does the MPB curve slope upwards or downwards?

A

Downwards

43
Q

On a diagram does the MPC curve slope upwards or downwards?

A

Upwards

44
Q

On a diagram where does the free market equilibrium occur and why?

A

The FM equilibrium occurs when MPC = MPB as in a free market consumers only consider their private costs and private benefits and ignore any social costs and benefits

45
Q

On a diagram where does the socially optimal level of output occur and why?

A

Where MSC = MSB because this includes the external costs and benefits to society

46
Q

What will the socially optimal level of output give society in terms of externalities?

A

The socially optimal level of output and price will give society the maximum benefit of any positive externalities and still cover up the cost of any negative externalities

47
Q

What is caused by ignoring negative production externalities?

A

Overproduction

48
Q

What causes overproduction?

A

Ignoring negative production externalities

49
Q

On a negative production externality diagram why does MPB = MSB

A

As there are no positive externalities

50
Q

Why does ignoring negative externalities in production lead to overproduction and under-pricing of a good?

A

In the free market only private costs are considered so the level of output would be higher than the social optimum.
This would cause overproduction and under-pricing of a good as more is produced and sold at a lower price than is desirable for society.

51
Q

What is the relationship between the marginal social cost and marginal social benefit for a good produced between the FM equilibrium and the social optimum?

A

For each unit of a good produced between the FM equilibrium and the social optimum the marginal social cost is greater than the marginal social benefit

52
Q

What is the area of the triangle between the marginal social cost and marginal social benefit equal to on a negative externality diagram?

A

Welfare loss

53
Q

Define the term welfare loss

A

The welfare loss is the loss to society caused by ignoring externalities

54
Q

What does the welfare loss/gain triangle always point to?

A

The social optimum

55
Q

What does ignoring positive consumption externalities lead to?

A

Underconsumption

56
Q

What causes underconsumption?

A

Ignoring positive consumption externalities

57
Q

On a positive consumption externality diagram why is MPC = MSC?

A

As there are no negative externalities

58
Q

Why does ignoring positive consumption externalities lead to underconsumption and under-pricing of a good?

A

In a free market only private benefits are considered which causes underconsumption and under-pricing of a good - less is consumed and sold at a lower price than is desirable for society.

59
Q

What is the relationship between the marginal social benefit and marginal social cost for a good produced between the FM equilibrium and the social optimum?

A

For each unit of this good consumed between the FM equilibrium and the social optimum the marginal social benefit is greater than the marginal social cost

60
Q

What is the area of the triangle between the marginal social benefit and marginal social cost equal to?

A

Welfare gain

61
Q

Define the term welfare gain

A

The welfare gain is the gain to society lost by ignoring externalities

62
Q

What are some examples of services with positive consumption externalities?

A
  • Education
  • Healthcare
63
Q

What is the relationship between education and healthcare and the free market?

A

In the free market both of these services are under-consumed and the potential welfare gain to society is lost

64
Q

Draw a diagram showing a negative externality in prodcution

A

See page 76

65
Q

Draw a diagram showing a positive externality in consumption

A

See page 76

66
Q
A

Edexcel A Economics Themes 1 and 2 (25 decks)

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