Misallocation of Resources

Question 1

define market failure

Answer 1

occurs when the market system is unable to allocate resources efficiently

Question 2

state some reasons why there is a misallocation of resources

Answer 2

• public goods allow people to consume a good without paying for it, therefore firms cannot make a profit from providing them
• monopolies can restrict output and raise price, under-providing goods to the market
• the provision of demerit goods, that are bad for the society are overconsumed whilst merit goods that benefit society are under consumed

Question 3

explain some of the costs associated with misallocation of resources

Answer 3

• de merit goods are over provided by the market, creating negative externalities that are deemed as bad for the society: drugs and cigarettes
• merit goods are over provided by the market, greater consumption would benefit individuals and society as a whole: health and education
• monopolies restrict output to raise price which leads to lower sales. consumers lose out because they would be prepared to buy more at the original price thus their existence leads to under-provision to the market

Question 4

give some reasons on why the government intervenes to counteract misallocation of resources

Answer 4

• to reduce or eliminate negative externalities
• increase or maximise positive externalities
• increase the supply of merit goods
• decrease the supply of de merit goods
• restrict the power of monopolies to improve the allocation of resources

Question 5

explain how the government intervenes: indirect taxation

Answer 5

• taxation is the medium through which governments finance their spending and control the economy
• an indirect tax is a tax on a good or service
• the imposition of an indirect tax will lead to an increase in the cost of supply for a firm - this will lead to a reduction in supply and prices will increase

Question 6

explain how the government intervenes: subsidies

Answer 6

• subsidies is the amount of money paid to a producer in order to increase the supply of a product
• the provision of subsidies will lead to lower costs for the firm, thus increasing supply
• is it normally provided by the government, although it can be provided by the private sector
• they are normally given to firms that produce merit goods, providing an incentive to supply them
• this is likely to lower the price to the consumer
• they are also provided to increase employment in the economy