Microeconomics 1.3 Flashcards
When does market failure occur
When the price mechanism is unable to efficiently allocate scarce resources to meet the needs of society. It is the role of the government to try and eliminate market failure
Complete market failure
When there is no market whatsoever ie. missing market. Goods and services will not be supplied to the market as firms will not receive revenue for supplying the product
Partial market failure
When a market exists but there is a misallocation resources. Goods and services will be supplied but in the wrong amounts eg. merit and demerit goods
Types of market failure
- Externalities
- Public goods
- Imperfect market information
When do externalities occur
When producing or consuming a good or service cause an impact on third parties not directly involved in the transaction.
They live outside the initial market transaction/ price
What are private costs
Costs faced by the producers and consumers directly involved in the transaction
What are private benefits
Benefits for producer and/ or consumer directly involved in a transaction
Relationships between externalities and private/ social costs of production
social costs = private + external costs
social benefit + private + external benefits
When does negative production externalities occur
Costs to third parties as a result of the actions of producers (MPC<MSC)
When do positive production externalities occur
Benefits to a third party as a result of actions of a producer (MSC>MPC)
What is welfare gain
The situation where the social cost is lower than the private cost and society gains as it does not have to pay for difference
When do negative consumption externalities occur
When the activities of consumers cost a 3rd party that are not included in the price of the economic activity (MSB<MPB)
When do positive consumption externalities occur
When the activities of consumers lead to benefit to a 3rd party that are not included in the price economic price (MSB>MPB)
Examples of positive externalities of consumption
- Healthcare (herd immunity)
- Education
- Exercise
Examples of positive externalities of production
- producing electric cars
- solar panels
- in-house training (other companies able to poach workers)
Examples of negative externalities of consumption
- Driving
- Getting drunk
Examples of negative externalities of producers
- Air pollution
- Deforestation
Evaluation of externalities
Very difficult to measure
Analysis of positive externalities in production
By not increasing production we lose pout on extra welfare
Individual producers, firms only consider their private costs rather then social costs (they ignore any external benefits) due to self interest
Therefore resources are allocated at the private optimum instead of the social optimum
Under production/ consumption
There is a misallocation of resources
Analysis of positive externalities in consumption
Individual consumers are ignoring social benefits of their actions and only consider their private benefit due to self interest
Therefore resources are allocated at the private optimum instead of the social optimum
The market allocates resources at the private optimum which leads to under consumption, under production
There is a misallocation of resources
Analysis of negative externalities in production
Firms ignore the full social costs and only focus on private costs due to self interest
Therefore resources are allocated at private optimum
This results in over production and over consumption as the price is too low
There is a misallocation of resources
Analysis of negative externalities in consumption
Consumers ignore the full social benefit of their actions and only look at the private benefit due to self interest
Therefore resources are allocated at the private optimum instead of the social optimum
This leads to over consumption and production of a product and there is a misallocation if resources
What are public goods
The two main characteristics of public goods are they are non-rivalrous and non-excludable.
Non-rivalry: Public goods are non-rival as consumption by one person does not reduce the supply available for others
Non excludable: Public goods are non-excludable as the benefits derived from them cannot be confined solely to those who have paid for them. Non-payers can enjoy benefits of consumption at mo financial costs to themselves
What is the free rider problem
Individuals have an incentive to use goods without contributing towards costs
Because public goods are non-excludable it is difficult to charge people for benefiting once a product is available
