The Meaning of Market Failure (price mechanism)

Question 1

How does market failure occur?

Answer 1

when the price mechanism leads to a misallocation of resources, either completely failing to provide a good or service or providing the wrong quantity with an adverse affect on societies welfare

Question 2

When does a complete market failure occur?

Answer 2

This occurs when no market exists

Question 3

What are the three characteristics of public goods?

Answer 3

Non-excludability, non-rival consumption, non-rejectable

Question 4

What is the meaning of non-excludability?

Answer 4

The benefits derived from public goods cannot be confined solely to those who have paid for it.

Question 5

What is the meaning of non-rival consumption?

Answer 5

Each party’s enjoyment of the good or service does not diminish others’ enjoyment – in other words the marginal cost of supplying a public good to an extra person is zero. ​

Question 6

What is the meaning of non-rejectable?

Answer 6

The collective supply of a public good for all means that it cannot be rejected by people

Question 7

Give an example of a public good.

Answer 7

public service broadcasting, crime control for community, reduced risk of disease due to vaccines

Question 8

Why can’t public goods be left to the market?

Answer 8

because there is no incentive for the private sector to provide because there is no profit to be made.​

Question 9

What is the free rider problem?

Answer 9

when it is impossible to prevent others from receiving the benefit from the good once provided

Question 10

What is a partial market failure?

Answer 10

where a market does exist but fails to provide the optimal quantity or the price is wrong

Question 11

What is government intervention?

Answer 11

government intervening in markets to either produce more, or influence market prices to correct the under or over consumption

Question 12

What is quasi public good?

Answer 12

a good which has some of the qualities of a public good but does not fully possess the two required characteristics of non-rivalry and non-excludability.​

Question 13

What is an externality?

Answer 13

an external benefit or cost that is ‘dumped’ on 3rd parties outside the market

Question 14

What are the four reasons for market failure?

Answer 14

Externalities, overconsumption/overproduction, underconsumption/underproduction, information gaps, missing markets

Question 15

What is the purpose of a market?

Answer 15

a place for buyers and sellers to meet in order to exchange resources to achieve goals such as utility maximisation​

Question 16

How do we know a market is at equilibrium?

Answer 16

where supply and demand is in balance, this is the point where the market price is correct, and production meets demand​

Question 17

Why is it good for a market to be at equilibrium?

Answer 17

There are no wasted resources; every economic agent has allocated their resources correctly​

Question 18

What moves a market equilibrium?

Answer 18

The price mechanism

Question 19

What does too high prices cause and how does the price mechanism correct this?

Answer 19

Excess supply will occur in this market, where Q2 will be supplied, but only Q1 will be demanded​

The signalling function will operate to tell suppliers that they will need to lower their prices to return the market to equilibrium​

Lower prices will incentivise more consumers to demand

Question 20

What occurs when prices become too low and how does the price mechanism correct this?

Answer 20

Excess demand will occur in this market, where Q2 will be demanded, but only Q1 will be supplied​

The rationing function will operate to force prices to rise due to consumers competing over limited supply, with the supply going to those who are willing to pay higher prices​

This will then incentivise firms to increase supply due to higher prices