The market mechanism, market failure and government intervention Flashcards
Define market failure
When a free market fails to allocate resources efficiently, leading to a loss in social welfare.
(world would be better off if we consumed more or less of a product)
What is a private cost/benefit?
Impacts people involved in the decision making process, usually buyers and sellers.
What is an external cost/benefit?
Impacts people not involved in the decision making process, otherwise known as a 3rd party.
What is a social cost/benefit?
Social cost/benefit = private cost/benefit + external cost/benefit
How do people make decisions?
Selfishly - only taking into account private costs and benefits.
How do we wish people would make decisions?
It would be better for society if people took into account the social costs and benefits.
How is overcosumption a market failiure?
People choose to consume based on private costs and benefits, but in doing so make society worse off. For example, too many people choose to smoke despite the external cost to the environment and NHS - the market has failed.
What is underconsumption.
When people consume too little of a product as they only take into account the private benefits, not the social benefits.
For example, vaccines, electric cars, education
What is an externality?
Externalities exist when people make decisions without taking into account the costs and benefits to third parties.
What is a positive externality?
When people don’t take into account the external benefits (social > private benefit) of consuming a product leading to underconsumption.
What is a negative externality?
When people don’t take into account the external costs (social >private costs) of consuming a product leading to overconsumption.
What is a marginal cost/benefit?
The effect of consuming or producing one more unit.
