Microeconomics: market failure Flashcards
What is price?
The sum of money you have to pay for a good or service. It is determined by the interaction of supply and demand.
What is cost?
How much money it takes the product to provide it.
Is price a reflection of worth?
Price is used to indicate worth, but is not accurate in all cases.
Worth is how much you value something. It can vary between different people, due to fashion or in different situations.
What is the best production level?
Where average production costs are at their lowest and the profit margins is at its highest.
What is efficiency?
The optimal production and distribution of scarce resources.
What are the 3 important functions that price fulfils when determining the efficient distribution of resources?
Signalling
Transmission
Rationing
What is signalling?
Prices provide information to buyers and sellers.
Prices give us information to help us makes decisions about what to buy.
How do prices create incentives for people to alter their economic behaviour?
Higher prices will encourage owners of resources to supply more e.g. homeowners will be encouraged to put their houses on the market when prices are high, but may withdraw it from the market if prices are too low.
What is rationing?
Prices help to ration scarce resources. If resources are scarce, the prices rises, so only those willing and able to pay the price are allocated the resources.
e.g. housing (biding for the highest price)
How has changing prices led to businesses allocating their resources?
Changing relative prices allocate resources away from markets exhibiting excess supply and into markets in which there is excess demand.
e.g. Demand for DVDs players has risen instead of VHS video players. This has led to a rise in the price of DVD players and a fall in the price of video players. This in turn led to resources moving from producing video players to DVDs.
What is the role of markets in the determination of price?
The determination of price is the interaction of the free market forces of supply and demand to establish the general level of price for a good/service.
Sometimes, the seller sets the price, and sometimes it can be negotiated with the buyer.
If the price is set too high, there will be excess supply (surplus).
If the price is set too low, there will be excess demand (shortage).
In both these situations, the market is in disequilibrium.
For competitive markets to work efficiently, both consumers and producers must respond to price signals.
What is the role of markets in the allocation of resources?
The allocation of resources is how scarce resources are distributed among producers, and how scarce goods and services are allocated among consumers.
In a market system, scarce resources are rationed, incentives are given to producers to supply more, and signals are offered to producers, consumers, and owners of factors of production.
Consumer spending decisions send signals to producers about what to produce, and how much.
If consumers are prepared to pay more, producers move scarce resources to produce more of it.
This power/influence of consumers is called consumer sovereignty.
The market system is therefore a means of achieving the efficient allocation of resources.
What are advantages of the price mechanism?
In a competitive market, it promotes consumer sovereignty. Firms and industries that produce goods other than those for which consumers are prepared to pay, do not survive.
Therefore through cost reduction, the price mechanism leads to a productively efficient allocation of resources.
By redistributing resources into the production of goods and services that people wish to buy, the price mechanism achieves allocatively efficient outcome.
What are the disadvantages of the price mechanism?
Free market economists believe that markets work well and government intervention works badly.
Risk of government failure which produces outcomes worse than market failure.
Some believe the price mechanism should be extended into parts of the economy previously dominated by state provision and the operation of the command/planning mechanism.
Interventionists, though, believe markets often perform badly and so government intervention and planning can help improve on the free operation of the price mechanism.
What are public goods and what are the characteristics of it?
Non-rival consumption by one person does not reduce the supply available for others, and it is non-excludable. It is usually provided collectively by the state, e.g., street lights are available for everyone.
The benefits derived from them cannot be confined solely to those who have paid for them. Non-payers can enjoy the benefits of consumption at no financial cost to themselves e.g. fireworks.
This leads to the free-rider problem. (someone benefits from a product without paying for it)
What are examples of public goods?
Vaccinations, national parks, crime control for a community, flood defence projects
What are private goods and what are the characteristics of it?
Highly excludable, sellers can easily prevent individuals who have not paid for the good from consuming it. Excludability allows for the enforcement of property rights and the collection of payment.
Rival in consumption - when one person consumes or uses a private good, it reduces the quantity available for others to consume. (there is competition/rivalry among consumers for the same resource) e.g. education, meals in a restaurant.
Typically priced in markets based on supply and demand, and consumers pay for what they consume.
What ate examples of private goods?
Private gyms, exclusive clubs, tickets to an event
Why does the government finance public goods?
Non-excludability - taxation ensures that everyone contributes to the funding of public goods, preventing free-rider problem and ensuring that the costs are distributed across the population.
Economies of scale - producing public goods for a larger population can lead to lower per capita costs. (government bulk-buy for everyone) Taxation allows governments to collect funds from a broad tax base, which can be more cost-effective in providing these goods compared to private firms or individual transactions.
Public interest and equity - taxation allows governments to allocate resources based on societal priorities and ensure that public goods are provided in a way that promotes social welfare and equity.
Why is there higher state spending on public goods?
Economies of scale - more efficient in providing public goods at state level leading to a lower long run cost per user.
How are technological changes blurring the distinction between some public and private goods and services?
Encryption allows suppliers to exclude non-payers although the product remains non-rival.
Technological progress reduces the cost of smart metering used in road pricing - this makes roads more of a private (excludable) good.
The open source/creative commons movement has made much digital information public good in nature - available to all - this information is non-rival and non-excludable. This made private goods more available to everyone, compared to those in the past e.g. information, eBooks.
Therefore, improvements in technology have enabled public goods to turn private.
What are quasi-public goods?
Semi non-rival - up to a point. consumers using a park or road do not reduce the space available for others.
But beaches can become crowded as do parks/leisure facilities and open-access Wi-Fi networks become crowded.
Semi non-excludable - it is possible but difficult or costly to exclude non-paying consumers such as fencing a park and charging an entrance fee ; or tail booths.
What is the free-rider problem?
Because public goods are non-excludable it is difficult to charge people for benefiting once a product is available.
Free riders have no incentive to reveal how much they are willing and able to pay for a public good.
Leads to under-provision of a good and thus causes a market failure (less than socially optimal amount).
Pure public goods are not normally provided by the private sector because they would be unable to supply them for a profit.
Pure public goods lead to missing markets - market failure (someone who benefits from a good/service without paying for it. e.g. Streetlights, Netflix- made it difficult to password share.
How can the free-rider problem be overcome?
Compulsory taxation to fund the collective provision of services e.g. national defense systems.
Appealing to people’s altruism and sense of social purpose.
Community solutions e.g. establishing social norms to manage common pool resources. (showing people the consequences of free-riding)
Government legislation - regulations enforceable in law e.g. fishing quotas, copyright and patent laws to protect intellectual property.
What is market failure?
Occurs when the market mechanism (supply and demand) fails to allocate resources efficiently and in the best interests of society, either completely failing to provide a good or service or providing the wrong quantity.
(when the market fails to deliver a level of output that is socially optimal)
What is complete market failure?
A market fails to function at all and a “missing market” results.
What is partial market failure?
A market does function, but it delivers the “wrong” quantity of a good or service, which results in resource misallocation e.g. too much junk food, cigarettes.
What are externalities?
Untended side effects or consequences of an economic activity or transaction that affect third parties who are not directly involved in that activity or transaction.
Effects can be positive or negative and are typically not reflected in the costs/benefits considered by the individuals or entities involved in the activity.
e.g. education - leads to less crime, skilled workers which is good for society but can lead to traffic, higher house prices in local areas.
What are negative production externalities?
Impact on society is coming from the production of the good e.g. factory pollution emissions, electric cars, waste from manufacturing processes.
What are negative consumption externalities?
When the consumption of a good or service imposes costs or harms on third parties who are not involved in the transaction e.g. smoking, noise and air pollution.
What are positive production externalities?
When the production of a good or service creates benefits for others not involved in the market transaction e.g. reforestation projects, research and development.
What are positive consumption externalities?
When the consumption of a good or service generates benefits for others who are not involved in the consumption decision e.g. vaccinations, public transport.
What are private costs?
Internal costs faced by the producer or consumer directly involved in a transaction. e.g. private cost of owning and running a vehicle.
What are external costs?
When the activity of one agent has a negative effect on the well-being of a third party, they impose costs on other agents. This causes social cost > private cost e.g., drinking.
What is the social cost?
Private cost + External cost
What are merit goods?
Generate positive externalities - where the social benefit exceeds the private benefit. e.g. education, healthcare, clean energy - often under-consumed so the government often subsidies them.
