The Market Mechanism, Market Failure and Government Intervention Flashcards
Define Market Failure
Where resources are inefficiently allocated due to imperfections in the working of the market mechanism- there is a misallocation of resources.
When does complete market failure occur?
When the market simply does not supply products at all- leads to “missing markets”
When does partial market failure occur?
When the market does actually function but it produces either the wrong quantity of a product or at the wrong price.
What are private goods and services?
Excludable, rival and rejectable
How are private goods excludable?
Consumers of private goods can be excluded from consuming if they are not willing and able to pay. Because owners of a private good are able to exercise private property rights.
What are property rights?
The legally recognised ownership of an economic resource giving the owner the exclusive right to determine how the resource is used. Owners of a private good are able to enforce these rights e.g. no entry to a football game without a ticket.
How are private goods rival in consumption?
One person’s consumption reduces the amount left for others to consume.
How are private goods rejectable?
Private goods can be rejected if you don’t want to consume them.
Why will the private sector supply private goods?
Because they can exercise their private property right and charge consumers and make a profit.
What are public goods and services?
Non-excludable, Non-rival and Non-rejectable.
How are public goods non-excludable?
- The benefits of pure public goods are not confined to those who have paid for it because there are no enforceable property rights. e.g. flood defences as non-payers enjoy the benefits of consumption at no financial cost.
- Although a supplier could exclude individuals if they did not pay - they could enforce property rights which may not be cost effective. e.g. putting fences on the beach and making people pay to go on a beach
How are public goods non-rival in consumption?
Consumption of a pure public good by one person does not reduce the availability of the good to others. e.g. defence
How are public goods non-rejectable?
If a pure public good is provided, we cannot avoid it whether we want it or not.
What is the Free rider problem (excludability) ?
As pure public goods are non-excludable consumers have an incentive not to contribute because they will receive the benefit of the good whether they contribute to it or not. e.g. TV license dodgers
What is the free rider problem (rivalry)?
Consumers know that the same amount will be available to them as everyone else whether they pay or not. So everyone will wait for someone else to pay, knowing they will receive the benefit.
Do private firms provide pure public goods?
No, due to the free rider problem private firms will not be able to make any profit.
Who normally provides pure public goods?
The government on the grounds of equity, and financed through general taxation or other forms of charge e.g. TV license fee.
What are some examples of pure public goods?
- National defence systems
- Lighthouse protection
- Street lighting
- Firework displays
- Flood defences
What are Quasi-public goods?
Products that are public in nature but exhibit some feature of excludability or rival depending on circumstances.
What some examples of a quasi public good?
A public good may become congested at peak times making it rival (roads) or a goof could be made excludable through the use of technology (subscription TV)
- Parks
-Police Force protection (rival)
- Beaches
Why does the state provide public goods?
- to correct for market failure as without them there would be missing markets
- on the grounds of equity as a government is out to maximise the welfare of its people
- on the grounds of efficiency as it could be easier to provide the good collectively and could have lower average costs of production.
When does the state not provide public goods?
When the good is quasi-public due to excludability as there is an incentive for the private sector as they can make profit.
Where has technology made a private good more public?
In the music industry where music was previously sold with physical CDs and is now sold on streaming sites for basically free so many artists give there music away for free because it is more cost effective. Led to increase in live music.
What are Public Bads (excludability)?
Goods from which no one is excluded from the disbenefits because of a lack of allocated property rights (no one owns the atmosphere) so the polluter free rides by passing on the cost of their pollution onto other people.
What are public bads (rivalry)?
The amount of disbenefit one person receives does not reduce the amount of disbenefit any other person receives.
What are negative externalities (external costs)?
The external costs that are imposed on a third party by an economic activity
What are positive externalities (external benefits)?
When an activity results in a benefit accruing to a third party.
What can positive and negative externalities be seen as?
A type of public good and a public bad.
How are externalities similar to public goods?
They are both non-excludable and non-rival.
How are externalities non-excludable?
There are a lack or lack thereof any property rights which will allow people to free ride both willingly and unwillingly resulting in market failure.
What is the social (S), private (P) and external (E) equation for both costs and benefits?
S = P + E
What are private benefits?
The total gain a consumer gets from consuming a good or service.
What are private costs?
The total monetary costs a firm has to pay to produce goods or services.
What are public costs and benefits?
The gains/ costs made/ suffered by third parties.
What does the concept of the margin relate to?
Anything connected to the last unit bought/ consumed/ produced
What is marginal social cost?
The total cost society has to pay to produce the last unit.
What is marginal social benefit?
The total benefit which society gains from the consumption of the last unit.
Which curve does production externalities relate to?
Cost curve
Which curve does consumption externalities relate to?
Benefit curve
What is the relationship between costs and benefits for negative production externalities?
MSC>MPC
What is the relationship between costs and benefits for positive production externalities?
MSC<MPC
What is the relationship between costs and benefits for positive consumption externalities?
MSB>MPB
What is the relationship between costs and benefits for negative consumption externalities?
MSB<MPB
What is the idea of the margin?
Relates to anything connected with the last unit bought/ produced/ consumed.
With an example, explain why the lines diverge.
The greater the amount of a product produced/ consumed the greater the volume of negative externalities e.g. pollution so the lines diverge.
What are the problems with calculating MSC?
- Hard to identify who has been negatively affected e.g. how far should we look, how badly does a 3rd party have to be before they are affected?
- Hard to ensure that all harms are accounted for e.g. some negativities happen later like disease
- Hard to place a value on the harm recieved by 3rd parties e.g. Heathrow homes and noise
- Some unansered Qs e.g. re-distributing money may be difficult, bureaucratic system = high cost
What is bureacracy?
The process (form-filling etc.) to get money to who needs it- is mostly costly and inefficient
What is the purpose of government intervention?
To try and reduce production/consumption of goods and services which have negative externalities and vice versa encourage … which have positive externalities.
How can government intervention be done?
Legislation/regulation
Education
Taxation
State/subsidised provision
Behavioral economics
What is a merit good?
A good which gives rise to SIGNIFICANT positive consumption externalities and, as a result, is under consumed in the free market.
What does the government think about merit goods?
They feel that people will under consume merit goods, and which ought to be subsidised or provided free and funded by the government.
Can both the public and private sector provide merit goods?
Yes both provide merit goods e.g. private schools and healthcare
What does the consumption of merit goods generate?
Positive externality effects
How does underconsumption of merit goods also arise?
From imperfect information- the consumer undervalues the private benefit they receive from the consumption.
How does society value some merit goods?
They believe everyone should have regardless of whether an individual wants them or not e.g. education
Give some examples of merit goods.
Main examples: Health services, Education. Other include: Work training programmes, Environment improvment schemes, cultural facilities e.g. museums, Social services, Inoculation programmes for children and students e.g. vaccines- Covid
What is the relationship between merit goods and value judgements?
When defining merit goods we are inevitably using value (normative) judgements. our views on what is ‘good’ and ‘bad’ for consumers and producers involve value judgements and state paternalism.
What is a demerit good?
A good which gives rise to SIGNIFICANT negative consumption externalities and, as a result, is over-consumed in the free market.
What does the consumption of demerit goods generate?
Negative externality effects
How and why does over consumption of demerit goods also arise?
From imperfect information where the consumer over-values the private benefit they receive from the consumption of the product.
Give some examples of demerit goods.
Smoking, Obesity, Gambling, Drug Addiction and Alcohol.
What are some strategies to control consumption?
Health awareness (education), Taxation, Statutory regulation/ legislation, subsidising healthier substitutes.
What are the causes of imperfect information/
Ignorance of the true costs or benefits- producers don’t supply enough information or the consumer may choose to ignore warnings, delayed gratification/costs- savings for pension or smoking, problems of using complex information- choosing computer brands or switching broadband provider, inaccurate or misleading information, addiction.
When does Asymmetric information occur?
When somebody knows more than somebody else in the market. Such asymmetric information can make it difficult for the two individuals to a transaction to do business together.
What does factor immobility do?
Places barriers to the movement of factor inputs to their most productive use- not on PPF curve meaning it is not productively efficient and allocating resources efficiently which is mkt. failure.
What does a loss of productive efficiency lead to?
Higher costs for businesses, higher prices for consumers and a loss of potential output.
What are the 2 types of factor immobility?
Geographical immobility- physically moving and Occupational immobility
What can labour immobility also be?
Unwillingness as well as inability to move jobs or from job to job as well as from unemployment to job.
Give 3 examples of geographical immobility in labour.
Family and other social ties e.g. educational priorities for children, * Regional variations in house prices and shortages of rented property.
What are some possible government policies to improve geographical mobility?
Improve the supply of housing and reduce the price of rented properties, Offer subsidies for people moving into areas where there are shortages of labour, harmonisation of welfare and tax systems to encourage easier movement of labour.
What is occupational immobility?
Barriers to the mobility of factors of production between different industries and occupations.
How are some capital goods occupationally mobile/immobile?
A computer can be used productively in many different industries but some capital is specific to an industry.
What is an example of occupational immobility of labour?
Workers made redundant in the metal industry may posses specific skills that are not transferable to other indutries where demand for workers is expanding. This leads to a waste of scarce resources and a loss of efficiency.
How can governments try to improve occupational mobility?
Training schemes and increasing investment in education.
What is regulation?
A set of rules
What is the regulator?
An organisation (usually independent from gov.) that ensures rules are followed and imposes penalties if they are not.
How has regulation been used for negative production externalities?
ULEZ, MOT emissions tests
How has regulation been used for positive production externalities?
Increasing supply of council housing, (subsidising R&D)
How has regulation been used for negative consumption externalities?
Banning drinking/ smoking in public places in certain areas.
How has regulation been used for positive consumption externalities?
Have to be in some form of education up until the age of 18.
What is the purpose of education?
-To increase awareness
-Change social attitudes
-Reduce asymmetric information
(however there is no compulsion)
What is the purpose of legislation/regulation?
-Restrict/ encourage production/consumption
- Enforce change
(enforces you if you get caught)
When does government failure occur?
Occurs when government intervention leads to a net welfare loss compared to the free market solution.
How does the existence of externalities affect income?
Often where one consumer is paying less than the social cost of production, another will be paying a higher private cost as a result of the externality created.
What is an example of how the existence of externalities affect income?
If a chemical company pollutes a river, the consumers of the chemicals pay a lower price for their good because it would cost money to prevent the pollution. But water consumers pay a higher price as the water company is forced to pay more to produce clean drinkable water.
What is the tragedy of the commons?
-When a public good is used to such a level that it ceases to have the characteristic of non-rivalry.
-The worst case scenario of a lack of property rights is the tragedy of the commons.
-uncontrolled freedom to use a resource results in rivalry and may ultimately destroy the resource itself.
When does the tragedy of the commons occur?
When there are no allocated property rights to a resource and instead there is open access (communal ownership of the property rights).
What is the result of the tragedy of the commons (‘communal’ ownership)?
The over-exploitation of the resource and its potential destruction as a result.
What is the characteristics of the tragedy of the commons?
Non rivalry – one person’s use does not reduce the amount available to anybody else.
Why does the tragedy of the commons explain many of the examples of environmental mkt. failure where a lack of allocated property rights leads to the over-exploitation of a natural resource?
In many cases, the environment is a public good (non excludable – open access – e.g. the oceans/atmosphere and, up to a point, non rival - my use does not reduce the amount available to anyone else).
What are some examples of the tragedy of the commons?
- Overfishing in the North Sea
- Deforestation
- Dumping waste in the oceans
- Polluting the atmosphere
How can the government control environmental market failure?
-To extend property rights: either to itself (Govt owned property rights) or to individuals (private property rights).
-Regulation: These are regularly used by Governments. The value of the tax should be equal to the cost of the pollution.
-Pollution permits
What is the effect of extending property rights +example?
internalise the externality. e.g. the car owner now has to pay the cost of their car emissions/the asbestos firm has to pay the cost of the harm caused to their workers.
What are the 2 main problems with extending property rights?
- Difficult to extend effectively if a lot of individuals are involved in the transaction e.g. global warming
- It can be very difficult to calculate the exact cost of any externality created
What are some examples of environmental taxes?
Congestion charge in London or the Landfill tax.
What are pollution permits?
-These are a market based system of reducing pollution, creating private property rights over the atmosphere, albeit a system set up and controlled by the Government.
-The Government issues permits up to a fixed level and distributes them among those creating the pollution. Firms are then free to trade these permits between themselves.
What is the benefit of pollution permits?
They are seen by some as a more efficient way of reducing pollution than other traditional methods like regulation and tax.
What are some of the main sources of housing market failure?
Chronic undersupply of homes
Asymmetric information
Empty housing & homelessness
inequalities of wealth
Externalities in the building industry
Labour immobility due to high (rent)prices
What is the demand for housing?
The quantity of properties homebuyers are willing and able to buy at a given price in a given time period.
What are 3 elements that affect demand for housing?
Real incomes-living standards rise
Mortgage interest rates- increase in rates increases cost of loan on the purchase of the property
Consumer confidence- less optimism could delay purchasing homes.
also economic growth, unemployment and price of substitutes
What is housing supply?
the flow of properties available at a given price in a given time period. Supply will be a mix of new and older housing.
What are the main conditions of supply in the housing market?
Costs of production for construction companies e.g. employment costs, costs of land, costs of components and raw materials, planning costs
No. of said companies
Economies of scale achieved?
Amount og innovation in the sector- productivity boost
Tax or subsidies
Social housing
What are the reasons for low (inelastic) PES of housing?
Production time frame: can takes years, delays can increase time
Limited spare capacity and low stock levels: supply is often restricted by shortages of skilled labour e.g. plumbers, other factors inputs e.g. cement and bricks may be in scarce supply
What has this low PES meant?
That the demand for housing in the UK has consistently outstripped supply (excess demand), leading to persistent rises in the price of housing.
What problems can empty property bring?
Problems for neighbouring property such as depressing house values, vandalism, crime etc.
External cost to the economy as local council and emergency services use scarce resources to deal with these issues
What does poor quality housing lead to?
Regarded as demerit good. Leads to a decline in life expectancy, lower educational attainment and increase chance of illness-> external costs-> misallocation of resources.
How is there asymmetric information in the housing market?
Between buyers and sellers, leading to misallocation of resources.
Also inefficient buying/selling process: expensive and slow process that creates a welfare loss due to the misallocation of resources.
What are some of the external costs of building new homes?
noise and air pollution. loss of habitat and increased congestion.
Calculating these costs and benefits is hard as they are often hard to quantify.
What are some of the external benefits of building new homes?
Private: revenues for firms, utility for buyers, employment for workers
External: less crime, less environmental cost from new builds, local business benefit, value of nearby housing could increase.
What are some schemes to help the supply side of the housing market?
Loosening planning restrictions- removing red tape and greenbelt restrictions.
Building on brownfield sites-financial incentives
Encouraging self-build schemes
Building more social housing-increasing funding and ease of borrowing for councils
Increased innovation-improving productivity
Reducing no. of empty homes
What are some schemes to help the demand side of the housing market?
Encouraging more diverse types of home ownership e.g. part owner part rental schemes
Financial assistance to homebuyers e.g. right to buy -> unintended consequences
Rent controls- make renting more affordable but cause distrotion in the market.
What does capping rents do?
May reduce inequality but creates excess demand for rented property. Fewer buy to let owners see it as profitable and choose to sell reducing supply. illegal market may develop. Consequences depend on severity of rent cap and where.`
