Potential Market Failures Flashcards
What are externalities in markets?
Externalities occur when a transaction affects third parties who aren’t directly involved. Negative externalities include pollution, where the public suffers from environmental damage. Positive externalities occur when benefits, like education or vaccination, spread to society, improving overall welfare. In both cases, the market fails to account for the broader impacts, requiring government intervention, like taxes for negative externalities or subsidies for positive ones.
What is asymmetric information, and how does it lead to market failure?
Asymmetric information happens when one party in a transaction has more or better information than the other. This can lead to issues like** adverse selection** (buyers or sellers making decisions based on incomplete or misleading information) or moral hazard (one party takes on more risk because they don’t bear the full consequences). These problems often require regulation to ensure fair transactions.
What is monopoly power, and why does it cause market failure?
A monopoly occurs when one firm controls the entire market, which can lead to higher prices and lower-quality goods or services due to lack of competition. Monopolies can restrict output and exploit consumers, reducing overall economic welfare. Governments often regulate monopolies or encourage competition through antitrust laws to prevent these negative effects.
What is inequality as a form of market failure?
Inequality occurs when wealth, resources, or opportunities are unevenly distributed, causing parts of the population to be excluded from essential services, like healthcare or education. Markets alone may not correct for this, leading to social and economic problems. Governments often intervene with redistribution policies such as taxes and welfare programs to reduce inequality and improve access to resources for all.
What is public goods, and how do they lead to market failure?
Public goods are goods that are non-excludable (everyone can use them) and non-rivalrous (one person’s use doesn’t reduce availability for others), like national defense or clean air. Markets don’t provide public goods efficiently because people can use them without paying (free-rider problem), leading to underproduction. Governments typically step in to provide public goods.
What is the tragedy of the commons in market failure?
The tragedy of the commons occurs when individuals overuse a shared resource (like overfishing in oceans) because they have an incentive to maximise personal gain, but no one takes responsibility for conserving the resource. This leads to depletion of the resource, harming everyone in the long run. Governments or regulations are often needed to manage these resources.
How do merit goods contribute to market failure?
Merit goods are products or services that are beneficial for people but are under-consumed in a free market, like education or healthcare. People might undervalue these goods or lack information about their benefits. The government often intervenes by providing these goods or offering subsidies to encourage consumption.
What is the role of moral hazard in market failure?
Moral hazard occurs when one party engages in risky behavior because they don’t bear the full consequences of their actions. For example, if someone has insurance, they may take more risks because they know they’re protected. This can lead to inefficiencies and higher costs, and it often requires regulation to mitigate.
