Section 5: Market Failure Flashcards
When does a market fail
When the price mechanism fails to allocate scarce resources efficiently and society suffers as a result
What is an externality
The effects that producing or consuming a good or service has on people who aren’t involved in making, buying or selling and consumption of the good or service
What can happen if externalities are ignored
Market failure
What is a private cost
The cost of doing something to either a consumer or a firm
What is social cost
External cost plus private cost
What is marginal private cost
The cost of producing the last unit of a good
What is marginal social cost
The marginal private cost plus the external cost
How can you see the external cost on a diagram with Price, costs, benefits being the y-axis and quantity being the x-axis
The gap between the marginal social cost and the marginal private cost is external cost
If the marginal social cost curve is parallel to the marginal private cost then what does that tell you about the external cost
The external cost is constant
What is marginal private benefit
The benefit to someone of consuming the last unit of a good
What is marginal social benefit
The marginal private benefit plus the external benefit
What is the difference between the marginal private benefit curve and the marginal social benefit curve
The positive externalities
In a free market where does equilibrium occur with relation to the marginal private cost and the marginal private benefit and give 2 reasons why
Equilibrium occurs when the MPC=MPB
This is because in a free market consumers and producers only consider their private costs and private benefits - as a result the MPC curve can be seen as the supply curve of a good or service and the MPB curve can be seen as the demand curve
So equilibrium occurs when MPC=MPB
In a free market at what point is the socially optimal point
Where MSC=MSB
What happens to the production and pricing of a good if only the private costs are considered
Leads to overproduction and underpricing
What does the triangle where the MSC and MPC curves meet the MPC=MSC represent
The welfare loss or the welfare gain depending on the direction of the curves involved
What is welfare loss
The loss to society caused by ignoring externalities
What happens to the consumption and pricing of a good if only private benefits are considered
Leads to underconsumption and underpricing of this good
What is welfare gain
The impact of a government policy or decision taking into account the gains minus any losses
What are public goods
Goods that can be consumed collectively
What are the 2 main characteristics of public goods
Non-exludability - people cannot be stopped from consuming the good even if they haven’t paid for it
Non-rivalry/non-diminishability - one person benefiting from the good doesn’t stop others benefiting - this means that public goods have zero marginal cost because there’s no additional cost to extending the good to one more person
What are the 2 types of public goods
Pure public goods and non-pure or quasi public goods
What factor can change a good that once had the characteristics of a public good into a private good
New technology
Describe the provision of public goods
Public goods are under-provided by the free market
What is the free rider problem
Once a public good is provided it’s impossible to stop someone from benefiting from it, even if they haven’t paid towards it
Why are public goods underprovided by the free market (2 aspects)
Producers overvalue the benefit of a public good to raise the price and consumers do the opposite
The price mechanism doesn’t work if the free rider problem exists
What is the tragedy of the commons
The idea that people acting in their own best interest will overuse a common resource without considering that this will lead to the depeletion or degradation of that resource
What is symmetric information
Everyone has equal and perfect knowledge
What type of information is assumed in a competitive market
It’s assumed that there’s perfect information - buyers and sellers are assumed to have full knowledge regarding prices, costs, benefits and availability of products
What does symmetric information lead to if we assume the buyers and sellers are rational
Efficient allocation of resources in and between markets will take place
What is asymmetric information
When the buyer or seller has more information than the other
What are the 2 reasons for asymmetric information
Providers may lack information because they provide an unpredictable service
Moral hazard - This happens when people take risks because they won’t suffer the consequences themselves if things go wrong
If there is imperfect information how will this affect the consumption of merit and demerit goods
This will lead to merit goods being underconsumed and demerit goods being overconsumed
Give 4 reasons why merit goods are consumed less when there is imperfect information
Consumers may not know the full benefit of a merit good
Consumers may lack the information to decide which good or service is right for them
Consumers may not have the information on how harmful a demerit good is
Advertising for a demerit good may withhold or ignore any health dangers
Give a reason why demerit goods are consumed more when there is imperfect information
Information on a good may be too complex to understand
