Part 5 - Market Failure and Government Intervention

Question 1

What are the different types of market failure?

Answer 1

Irrational Behavior
Missing Markets/Public Goods
Externalities
Imperfect information
Factor Immobility
Market Power (Monopolies)

Question 2

What does the government provide?

Answer 2

Provision of Information
Regulation
State Provision
Tradeable Permits
Maximum Prices
Minimum Prices
Subsidies
Indirect Taxation
Nudges

Question 3

What is Asymmetric Information?

Answer 3

This is when consumers are overcharged or sold an inferior good as they don’t know the value of the product

Question 4

What is adverse selection?

Answer 4

Occurs when participation in the market is affected by asymmetric information. Eg health insurance provided at an average price, no matter whether you a smoker or not.

Question 5

What is Moral Hazard?

Answer 5

Occurs when people are more likely to behave more recklessly because they have insurance

Question 6

How does the government intervene the problem of imperfect information?

Answer 6

Through provision of information - through methods such as social media, newspapers, forcing companies to publish data ect

Question 7

What are examples of irrational behavior?

Answer 7

Consideration of other peoples behavior
Habitual behavior
Consumer weakness at computation

Question 8

What is ‘consideration of other peoples behavior’ ?

Answer 8

When people don’t act in their best interests (as economists usually assume) and instead do things to fit into a social group

Question 9

What is Habitual Behavior ?

Answer 9

Consumers form habits and aren’t willing to risk something where there is more uncertainty or deal with the difficulties of changing

Question 10

What is consumer weakness at computation?

Answer 10

Even if consumers want to make the most rational choice they may have a poor understanding of calculating probability or are unrealistic of their future behavior

Question 11

What are nudges?

Answer 11

Small suggestions and positive reinforcements that can influence consumer behavior

Question 12

What makes a good a private good?

Answer 12

If they are excludable, rivalrous and rejectable

Question 13

What makes a good a pure public good?

Answer 13

If they are non-excludable, non-rivalrous and non-rejectable

Question 14

What makes a good a quasi public good?

Answer 14

If it fulfills the criteria of being non-excludable, non-rivalrous and non-rejectable up to a certain point

Question 15

Examples of private goods

Answer 15

Pens, Paper, Cars, Surgery

Question 16

Examples of pure public goods

Answer 16

Fire Brigade, Air, National defense

Question 17

Examples of quasi public goods

Answer 17

WiFi, Parks, Roads, Lectures

Question 18

Would the free market provide enough public goods?

Answer 18

Producers have profit incentive. due to free rider problem there will be an under-provision of public goods as people may not pay for it

Question 19

What does the gov do due to the free rider problem?

Answer 19

The government has to provide public goods and it is funded through tax revenue

Question 20

Why is it hard for the gov to work out the value of public good provision?

Answer 20

Value of goods usually calculated by looking at what consumers would be willing to pay for it, due to free rider problem this is hard to do

Question 21

What is private cost?

Answer 21

costs internal to an exchange and paid by an individual economic agent

Question 22

What is a negative externality?

Answer 22

costs from production or consumption that have a negative effect on a third party

Question 23

What is social cost?

Answer 23

The overall cost to society of an economic decision (private + external cost)

Question 24

What is private benefit?

Answer 24

benefits internal to an exchange and are recieved by an individual economic agent

Question 25

What is a positive externality?

Answer 25

benefits from production or consumption that have a positive effect on a third party

Question 26

What is social benefit?

Answer 26

overall benefit to society of an economic decision (private + external benefit)

Question 27

When does an economy allocate resources efficiently?

Answer 27

When net social benefits are maximised (MSB = MSC)

Question 28

What are the advantages of indirect taxes?

Answer 28

Internalises the externality Raises revenue for govt Incentivises producers to innovate

Question 29

What are the disadvantages of indirect taxes?

Answer 29

May encourage black market for some products Demand could be inelastic so tax has little effect May force firms out of business (regressive)

Question 30

What are the advantages of minimum prices?

Answer 30

Reduces consumption of harmful goods No cost to govt Targeted at groups abusing product

Question 31

What are the disadvantages of minimum prices?

Answer 31

No effect if set below equilibrium Could encourage black market Less effective on goods with inelastic demand

Question 32

What are advantages of regulation (prohibition/restriction)?

Answer 32

Ensures social optimum is reached Required if demand is inelastic Could incentivise firms to innovate

Question 33

What are the disadvantages of regulation?

Answer 33

Requires monitoring (cost to govt) Overly harsh limits create costs to business, leading to higher costs and unemployment Limits could be set too low

Question 34

What are the advantages of extended property rights?

Answer 34

Ensures externalities are internalised Reduces burden on govt Those who own the resource are compensated

Question 35

What are the disadvantages of extended property rights?

Answer 35

Difficult to calculate value of damages Difficult to trace externalities High legal costs of prosecution

Question 36

What are the advantages of tradable permits?

Answer 36

Internalises the externality Incentive to invest into clean energy Emissions cut in an effective way Revenue for govt

Question 37

What are the disadvantages of tradable permits?

Answer 37

Difficult to issue right number of permits High cost of monitoring for govt May not be a worldwide system

Question 38

What are the advantages of subsidies?

Answer 38

Ensures social optimum is reached Lower prices for consumer Reduces inequality

Question 39

What are the disadvantages of subsidies?

Answer 39

Opportunity cost for govt Productive inefficiency - firms could just rely on subsidy Subsidy supplied could be wrong amount

Question 40

What are the advantages of maximum prices?

Answer 40

Helps reduce inequality Stops exploitation of consumer Low cost to govt

Question 41

What are the disadvantages of maximum prices?

Answer 41

There will be shortages No effect if set above equilibrium level No incentive for producers to improve quality

Question 42

What are the advantages of guaranteed minimum prices?

Answer 42

Provides reasonable level of income for producers Stops farmers from being exploited Provides cushion against future supply shocks

Question 43

What are the disadvantages of guaranteed minimum prices?

Answer 43

No effect if set below equilibrium Higher prices for consumers Creates incentive for wasteful excess supply Opportunity cost for govt

Question 44

What is government failure?

Answer 44

When government intervention makes resource allocation worse than it already is

Question 45

What is distortion of price signals?

Answer 45

Gov intervention can cause the market to move away from equilibrium, creating shortages

Question 46

What are unintended consequences?

Answer 46

Gov intervention may cause unexpected adverse effects E.g increasing benefits may result in unemployment

Question 47

What are excessive administration costs?

Answer 47

Gov bureaucracy can have a huge cost for taxpayers

Question 48

What are information gaps?

Answer 48

Imperfect information may create a welfare loss as gov may over or under subsidise/tax/regulate