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Economics MICRO > The Market Mechanism, Market Failure & Government Intervention > Flashcards

The Market Mechanism, Market Failure & Government Intervention Flashcards

1
Q

what is the price mechanism ?

A

the interaction of demand and supply in a market economy, that allocates scarce resources amongst competing needs and wants

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2
Q

what did Adam Smith refer to the functions of the market mechanism as ?

A

the ‘invisible hand of the market’

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3
Q

what 3 functions does the price mechanism fulfill ?

A

rationing,
incentivising,
signalling

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4
Q

what is the ‘rationing’ part of the price mechanism ?

A

When resources become scarce, the price will rise. Only those who can afford to pay for them will receive them. If there is a surplus, then prices fall and more consumers can afford them.

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5
Q

what is the ‘incentive’ part of the price mechanism ?

A

The incentive function encourages producers to increase or decrease output to increase profits.

-(When prices for a good/service rise, it incentivises producers to reallocate resources from a less profitable market in order to maximise their profits)
-(Falling prices incentivise reallocation of resources to new markets)

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6
Q

what is the ‘signalling’ part of the price mechanism ?

A

A change in price provides a signal to consumers and producers about where resources are wanted and where they are not

(High prices signals to a producer to produce more of that good/service and would signal to other producers to enter the market)
(A falling price signals to consumers to purchase more or a product)

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7
Q

what order does the price mechanism work in ?

A

1). rationing (of goods and services due to a change in demand or supply)
↧
2). incentivisng (producers to increase production
↧
3). signalling (other producers to enter the market because the demand for honey is strong)

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8
Q

what are the advantages of the price mechanism ?

A

There is an efficient allocation of resources under price mechanism as markets adapt to changes quickly

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9
Q

what are the disadvantages of the price mechanism ?

A

it may create inequality as only those with higher incomes have buying power
e.g. markets for donors

does not take into account consumer utility or decision making

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10
Q

why does the price mechanism exist ?

A

to determine the most efficient allocation of scarce resources in response to the competing wants and needs in the marketplace

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11
Q

what is market failure ?

A

when there is a less than optimum allocation of resources from the point of view of society.

(lack of allocative efficiency)

leads to a deadweight loss to society

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12
Q

what is a complete market failure ?

A

occurs when there is a missing market

the market does not supply products at all despite society having demand for it

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13
Q

what is a partial market failure ?

A

occurs where the market exists, but does not provide resources in optimum quantities

e.g. over production/ consumption or under production/ consumption of a good or service

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14
Q

what is the most common cause of a complete market failure (missing market) ?

A

where there is non-excludability and no enforceable property rights

(no way of charging consumers if everyone has access to the resources)

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15
Q

what are the 6 main causes of market failure ?

A

public goods

externalities

tragedy of the commons

merit and demerit goods

market imperfections

unequal distribution of income and wealth

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16
Q

why do public goods cause market failures ?

A

are beneficial to society but would be under-provided by a free market, because they are unprofitable as there are unexcludable therefore a price tag cant be put on them.

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17
Q

what are externalities ?

A

they occur when there is an external impact on a third party not involved in the economic transaction between the buyer and seller.

e.g. passive smoking, which is considered a negative externality

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18
Q

what is the Tragedy of the Commons ?

A

occurs when common resources (non-exludable and rivalrous) are used by either the producer or consumer in a way that is not sustainable

e.g. over-fishing

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19
Q

what does rivalrous mean ?

A

rivalrous goods can be used up

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20
Q

what are merit goods ?

A

goods or services that are beneficial to consumer and society

but the free market does not provide enough of them

e.g. education or healthcare

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21
Q

what are demerit goods ?

A

goods which have harmful impacts on consumers or society

e.g. cigarettes

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22
Q

what are the 3 types of market imperfections ?

A

1) imperfect information
2) monopoly power
3) factor immobility

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23
Q

what is imperfect information ?

A

when buyers and sellers have different levels of information in a market, this can distort market outcomes, resulting in market failure

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24
Q

what is factor immobility ?

A

when factors of production are unlikely to be perfectly mobile

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25
Q

what are public goods ?

A

goods that are beneficial to society

non-excludable and non-rivalrous

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26
Q

what are private goods ?

A

goods that firms are able to provide to generate profits

excludable and rivalrous

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27
Q

why are non-rivalrous goods beneficial ?

A

one person consuming it does not prevent another person from consuming it.

they are finite

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28
Q

if firms did decide to provide these goods anyways, what would occur ?

A

the ‘free rider problem’

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29
Q

what is the ‘free rider problem’ ?

A

where customers realise that they can still access the goods, even without paying for them

they stop paying and continue to enjoy the benefits. They are ‘free-riding’ on the backs of other paying customers

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30
Q

what are quasi-public goods ?

A

are non-pure public goods that have characteristics of public goods and private good

(elements of non-excludability or non-rivalry)

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31
Q

what is one way the ‘free rider problem’ can be minimised ?

A

technology

e.g. number-plate recognition and tracking on motorways for tolls

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32
Q

what is an externality ?

A

when there is an external impact on a 3rd party not involved in the economic transaction

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33
Q

when do negative externalties occur ?

A

when the social costs of an economic transaction are greater than the private costs

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34
Q

what is a private cost ?

A

is what a firm actually pays to produce a good/service

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35
Q

when do positive externalities occur ?

A

when the social benefits of an economic transaction are greater than the private cost

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36
Q

when are negative externalties of production created ?

A

during the production of a good/service

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37
Q

why do negative externalities occur ?

A

as only the private costs are considered by producers and not the external costs

therefore, firms will over-produce these goods and services, causing market failure

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38
Q

what is a market failure ?

A

when there is a misallocation of resources in a market

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39
Q

what does a negative externality of production curve look like ?

A

price level Y axis
quantity X axis

(because its production we are focusing on the supply curves)

2 supply curves
one lower named MPC
one higher named MSC
-this is because MSC are greater than the MPC-

the triangle space infront of the demand curve and inbetween the MSC and MPC is the negative externality & DWL to society that can be shaded in.

1 demand curve
named D=MPB=MSB

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40
Q

what does a negative externality of consumption look like ?

A

price level Y axis
quantity X axis

(because its consumption we are focusing on the demand curves)

2 demand curves
one lower named MSB
one higher named MPB
-this is because MPB are greater than the MSB-

the triangle space infront of the supply curve and inbetween the MPB and MSB is the negative externality & DWL to society that can be shaded in.

1 supply curve
named S = MPC = MSC

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41
Q

what does a positive externality of production look like ?

A

price level Y axis
quantity X axis

(because its production we are focusing on the supply curves)

2 supply curves
one lower named MSC
one higher named MPC
-this is because MPC are greater than the MSC-

the triangle space behind the demand curve and inbetween the MPC and MSC is the positive externality & DWG to society that can be shaded in.

1 demand curve
named D=MPB=MSB

however, consumers will have to suffer from higher prices and lower outputs

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42
Q

what does a positive externality of consumption look like ?

A

price level Y axis
quantity X axis

(because its consumption we are focusing on the demand curves)

2 demand curves
one lower named MPB
one higher named MSB
-this is because MSB are greater than the MPB-

the triangle space behind the supply curve and inbetween the MSB and MPB is the positive externality & DWG to society that can be shaded in.

1 supply curve
named S = MPC = MSC

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43
Q

what are common (Pool) resources ?

A

resources with no private ownership

non-excludable but rivalrous

e.g. oceans, natural forests etc.

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44
Q

what is the tragedy of the commons ?

A

occurs when common pool resources are used in an unsustainable way

creating negative externaltiies in production and consumption

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45
Q

why does the tragedy of the commons create negative externaltities ?

A

P: because there is no incentive for firms to reduce production levels as they seek to maximise profits

C: there is also no incentive for consumers to reduce consumption levels. If an individual consumer cuts back on consumption, other consumers will use the resource

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46
Q

what are solutions to address the tragedy of the commons ?

A

international agreements

appeal for ownership rights over land

47
Q

what are property rights ?

A

they define the ownership of a resource and set out how they can be used

48
Q
A
49
Q

what are some problems with property rights ?

A

equity (deciding who revives property rights)

cost of enforcement and regulation

divisibility (not easily divided)

50
Q

what are merit goods ?

A

products that are beneficial for society but the free market does not provide enough of them

51
Q

what are demerit goods ?

A

products which have harmful impacts on consumers or society

52
Q

what would the optimum allocation of resources for society generate ?

A

an equilibrium where (MSB = MSC)

53
Q

what is a partial market failure ?

A

a good/ service is provided but not a socially optimal level

54
Q

why can imperfect information lead to over-consumption of demerit goods or an under-consumption of merit goods ?

A

consumers may have incomplete or inaccurate information about the external consequences associated with merit or demerit goods

55
Q

what is a pure monopoly ?

A

when there is only one producer in the market

56
Q

Monopolies have market power and can set higher … ?

A

prices for consumers to earn supernormal profits

57
Q

what is the mobility of factors of production referring to ?

A

how easily firms can switch between different factors of production

58
Q

The more mobile the factors of production … ?

A

the more flexibility there will be in production

59
Q

if firms have high mobility of their factors of production they can be … ?

A

very responsive to changes in demand

60
Q

what are the 5 main reasons governments intervene ?

A
  • correct market failure (ensure resources are being allocated efficiently)
  • redistribute income & wealth
  • support firms
  • collect tax revenues
  • achieve macroeconomic goals
61
Q

what are the 7 main government interventions ?

A

indirect taxes
subsidies

price controls

state provision
regulation

property rights

pollution permits

62
Q

what is an indirect tax ?

A

a tax paid when goods and services are purchased

63
Q

what is the aim of indirect taxes ?

A

to increase cost of production for firms

leading to higher prices

reducing quantity demanded

64
Q

what are the advantages of using an indirect tax ?

A
  • Raises the price and reduces the quantity demanded of demerit goods
  • Reduces external costs of consumption and production
  • Raises revenue for government programs
65
Q

what are the disadvantages of using an indirect tax ?

A
  • The effectiveness of the tax (PED inelastic)
  • may lead to black markets
  • producers may be forced to lay off workers
66
Q

what is a subsidy ?

A

amount of money given to a firm by the government

67
Q

what is the aim of subsidy’s ?

A

reduces the costs of production and encourages an increase in the output of a good or service

lower prices

68
Q

what are the advantages of subsidies ?

A
  • A subsidy increases demand for merit goods
    -It lowers prices make goods more affordable to those on lower incomes reducing effects of poverty
  • Can be targeted to helping specific domestic industries
69
Q

what are the disadvantages of subsidies ?

A
  • It distorts the allocation of resources in markets
    E.g. it often results in excess supply when used in agricultural markets
  • There is an opportunity cost associated with the government expenditure
  • Subsidies are a disincentive for firms to become more efficient or competitive
70
Q

what are price controls ?

A

a type of government intervention
in markets to change the market price

correct market failure, influence the levels of production or consumption in markets

71
Q

how do price controls correct market failure ?

A

by influencing the levels of production or consumption in markets

72
Q

what are the 2 types of price controls used ?

A

maximum price (ceiling)

minimum price (floor)

73
Q

the price ceiling is set …. the existing market equilibrium ?

A

below

74
Q

when will governments use a price ceiling ?

A

if a market price is too high, especially for essential goods and services to help consumers

75
Q

what are the advantages of price ceilings ?

A

some consumer benefit (Lower prices)

stabilize markets in the SR

76
Q

what are the disadvantages ?

A

Some consumers are unable to purchase due to the shortage

Producers lose out as the price is below what they would usually receive: their producer surplus falls

The unmet demand usually encourages the creation of illegal markets and exploitation of consumers

77
Q

the price floor is set … the existing market equilibrium ?

A

above

78
Q

when will governments use price floors ?

A

Governments will often use price floors to help producers or to decrease consumption of a demerit good

79
Q

what are the advantages of price floors ?

A

In agricultural markets, producers benefit as they receive a higher price (Governments will often purchase the excess supply and store it or export it)

Producers are protected from price volatility

80
Q

what are the disadvantages of price floors ?

A

It costs the government to purchase the excess supply and an opportunity cost is involved

Some producers such as farmers may become over-dependent on the Government’s help

Producers lower output which may result in an increase in unemployment in the industry

If demand is price inelastic, the increase in price does not impact QD or solve the market failure

81
Q

what is competition policy ?

A

a government policy aimed to make market more competitive, to ensure public interest is protected.

82
Q

what are the main forms of consumer exploitation by firms ?

A

higher prices

lack of choice

poor quality products

83
Q

what is the main aim for competition policy to control ?

A

anti-competitive mergers and monopolies

(preventing restrictive trading practices and promote competition in markets)

84
Q

what does the CMA stand for ?

A

The Competition and Markets Authority

85
Q

what is the CMA ?

A

the UK Government regulator tasked with ensuring that the creation of monopoly power is avoided and that consumers are not exploited in markets

86
Q

why must monopolies be limited, in the governments opinion ?

A

monopolies can restrict output and raise prices to gain supernormal profit

  • This reduces consumer surplus
87
Q

what is consumer surplus ?

A

consumer welfare gain from consuming goods and services

88
Q

what are the 5 main competition policy’s ?

A

breaking-up monopolies

price regulation (maximum/ minimum prices)

profit regulation

taxation

public (state) ownership

89
Q

once the government have reduced monopoly power in a market, how do they then increase competition ?

A

1) promote small businesses

2) deregulation (reducing barriers to entry)

3) privatisation (encourages new firms to enter the market as they feel more confident to compete)

90
Q

what are the advantages of competition policy ?

A

+ Increased competition may lead to a fall in market price

+ Firms will strive to provide better quality and a range of products and customer service or risk losing market share

+ allocative and productive efficiency

91
Q

what are the disadvantages of competition policy ?

A
  • It can be expensive and time consuming to ensure firms or industries are complying with competition policies
  • reduces creative destruction (replacement of old technologies due to innovation & intervention) , firms with monopoly power are dynamically efficient as they can provide huge investment in R&D
  • may lead to government failure as the authorities create distortions in the market leading to inefficiencies
92
Q

what is public ownership ?

A

government ownership of firms, industries, or other assets

93
Q

what is privitisation ?

A

the transfer of assets from the public (state) sector into private ownership

94
Q

what is nationalisation ?

A

the transfer of assets from the private sector into public (state) ownership

95
Q

what type of goods tend to be nationalised ?

A

merit goods, and public goods

96
Q

what are the benefits of public (state) ownership / nationalisation ?

A

+ resources can be provided and allocated in such a way that benefits society as a whole, allocatively efficient way

+ can prioritise social welfare over profit

+ can yield strong positive externalities

97
Q

what are the drawbacks of public (state) ownership / nationalisation ?

A
  • The Government may lack the expertise to run the business
  • Higher expenditure for the government which means higher taxes
  • Publicly owned firms/industries tend to lack dynamic efficiency because they lack competition
98
Q

what are the benefits of private ownership / privatisation ?

A

+ Raises revenue for the government

+ Reduces public spending

+ May lead to productive efficiency and dynamic efficiency

99
Q

what are the drawbacks of private ownership / privatisation ?

A
  • Privatised, profit maximising monopolies can restrict output to generate supernormal profits
  • The price of the good/service usually increases as firms seek to maximise their profit
  • Private firms often provide a substandard goods or services as they cut quality to increase profits
100
Q

what is the regulation of markets ?

A

the process of monitoring and enforcing the laws

101
Q

why do the government create laws and rules that have to be regulated ?

A

to limit harm from negative externalities of consumption/production and to create competitive markets

102
Q

what are the advantages of regulation ?

A

+ lower prices which increases consumer surplus

+ positive externalities

+ extra government revenue

103
Q

what are the disadvantages of regulation ?

A
  • High costs of enforcement/ administration of laws
  • reducing profits for firms may compromise with dynamic efficiency
  • can act as a barrier to entry
  • black markets may be formed
  • may lead to regulatory capture
104
Q

what is deregulation ?

A

the process of removing government controls from markets

105
Q

what are the advantages of deregulation ?

A

+ In some markets, deregulation promotes contestability in markets allowing lower prices for consumers

+ removes excessive costs of regulation

106
Q

what are the disadvantages of deregulation ?

A
  • May create a private firm with monopoly power as smaller companies are unable to compete
  • Consumers may pay higher prices if the market is not regulated
  • Private firms have an incentive to cut costs and provide a lower quality of service
107
Q

what type of goods are unprovided in a free-market ?

A

merit goods (expensive)
&
public goods (non-excludable, non-rivalrous) leads to free-rider problem, unprofitable

108
Q

how do pollution permits work ?

A

Governments calculate an optimum (or preferable) level of pollution
Governments create a pollution permit market and issue permits to polluting firms
The price of the permit is determined by demand and supply
Each permit allows a firm to pollute up to a certain amount. Any surplus can be sold and traded for additional revenue
Firms that pollute more have to buy additional permits from less-polluting firms

109
Q

pollution permits: the cost of production represents an additional …….. ?

A

cost of production

110
Q

what are the advantages of pollution permits ?

A

+ switch to green production methods (reducing negative externality of pollution)

+ raises government revenue

111
Q

what are the disadvantages of pollution permits ?

A
  • Firms may relocate production to places where they can pollute without limits
  • Expensive and difficult for firms to monitor emissions
  • Firms may pass on higher production costs to the consumer
112
Q

when does government failure occur ?

A

when the government intervenes in a market to correct market failure, but the intervention results in a misallocation of resources from society’s point of view

113
Q

what are some causes of market failure ?

A

> inadequate information

> conflicting objectives

> administrative costs

> market distortions

> regulatory capture

Economics MICRO (8 decks)

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