Module 12 - Government intervention in markets Flashcards
Social efficiency
Production and consumption at the point where Marginal Social Benefit (MSB) = Marginal Social Cost (MSC), ie the best allocation of resources (allocative efficiency) for society.
Equity
The fair distribution of a society’s resources between individuals and between regions.
Explain why the social optimum occurs where MSB = MSC
The MSB is the additional benefit to society of an additional unit of a product and the MSC is the additional cost to society of an additional unit of a product.
If:
- MSB > MSC, then total welfare will increase by producing more of the product
- MSB < MSC, then total welfare will increase by producing less of the product
- MSB = MSC, then total welfare is at a maximum, ie any reallocation would lead to a reduction in net benefit (ie welfare)
The free market normally fails to achieve social efficiency.
List the main types of market failure
- Market power
- Externalities
- Public goods
- Merit goods
- Ignorance and uncertainty
- Immobility and time lags
- Inequality
Explain how each type of market failure causes an unsatisfactory (suboptimal or inequitable) allocation of resources
.
Consumer surplus
The difference between the maximum a person would have been prepared to pay for a good (ie. the utility measured in money terms) over what the person actually pays. Total consumer surplus equals total utility minus total expenditure.
Producer surplus
The difference between the minimum price required for a firm to supply a good and the price that is actually paid. Total producer surplus is the excess of a firm’s total revenue over total (variable) costs.
Total (private) surplus
It is the consumer surplus plus producer surplus.
Deadweight welfare loss
The reduction in total surplus below the maximum amount that is possible.
Externalities
Costs or benefits of production or consumption experienced by people other than the producers and consumers directly involved in the transaction. They are sometimes referred to as ‘spillover’ or ‘third-party’ costs or benefits.
Consumption externalities
Spillover effects on other people of consumers’ consumption.
Production externalities
Spillover effects on other people of firms’ production.
External costs
Costs of production (or consumption) borne by people other than the producer (or consumer) directly involved in the transaction.
External benefits
Benefits from production (or consumption) experienced by people other than the producer (or consumer) directly involved in the transaction.
Social costs
Private costs plus production externalities.
Social benefits
Private benefits plus consumption externalities.
Public goods
A good or service that has the features of non-rivarly and non-excludability.
Non-rivarly
Where the consumption of a good or service by one person will not prevent others from enjoying it.
Non-excludability
Where it is too costly to implement a system that would effectively prevent people who have not paid from enjoying the benefits from consuming a good.
Free-rider problem
When people enjoy the benefits from consuming a good without paying anything towards the cost of providing it.
Merit goods
Private goods which the government feels that people will under-consume and which therefore ought to be subsidised or provided free
Give examples of external costs and benefits of production
External costs of production:
Polluted rivers from a firm’s waste products
External benefits of production:
More efficient staff as a result of the training given by previous employers
Give examples of external costs and benefits of consumption
External costs of consumption:
Effects of passive smoking
External benefits of consumption:
Improved health of the nation as a result of a vaccination programme.
Give examples of public goods
Defence, policing, street lighting
Give examples of merit goods
Education, healthcare, pension, training
List the main types of government intervention
The government can intervene in the following ways:
- Persuading consumers and producers to modify their behaviour using:
- indirect taxes and subsidies
- extensions to property rights
- laws and regulatory bodies
- price controls
- the provision of information - Providing goods and services directly
- Welfare systems
Explain how each type of intervention aims to correct market failure
.
Discuss the relative merits of each type of government intervention
.
Explain the Coase theorem
When there are well-defined property rights and zero bargaining costs, then negotiations between the party creating the externality and the party affected by the externality can bring about the socially efficient market quantity.
Government surplus from a tax on a good
The total tax revenue earned by the government from sales of a good.
Excess burden of a tax on a good
The amount by which the loss in consumer surplus exceeds the government surplus.
List the problems caused by government intervention in a market economy
- Shortages and surpluses when price controls are used
- Problems caused by measurement difficulties and a lack of information
- Bureaucracy and inefficiency
- A negative effect on incentives
- The reduction in individual freedom of choice
- The adverse effect on efficiency if there are frequent changes in government policy.
Discuss the case for more or less government intervention
Less government intervention:
Though possessing many faults, a free market would benefit from
- automatic adjustments to changes in market conditions
- incentives for risk taking and innovation
- a competitive environment (even where oligopoly and monopoly is prevalent)
What are the two major objectives of government intervention
- Social efficiency
2. Equity
