theme 1- 1.3 market failure

Question 1

market failure

Answer 1

refers to the failure of the market system to allocate resources efficiently
arises because the price mechanism has not taken into account all the costs/benefits in the production or consumption of a good/service

Question 2

types of market failure

Answer 2

• externalities
• non-provision of public goods
• information gaps
• monopoly
• moral hazard
• immobility of labour
• speculation and market bubbles

Question 3

reasons for market failure

Answer 3

for resources to be efficiently allocated, it is necessary for social marginal costs (SMCs) to = social marginal benefits (SMBs)
- in practice, some costs/benefits may be unknown or difficult to quantify

Question 4

social marginal cost (SMC)

Answer 4

the addition to total cost of producing an extra unit of output

Question 5

social marginal benefit (SMB)

Answer 5

the addition to total benefits of consuming an extra unit

Question 6

externalities

Answer 6

costs and benefits to third parties who are not directly involved in a transaction between producers and consumers
arise for the production/consumption of a product or service that are not taken into account by the price mechanism

Question 7

types of externalities

Answer 7

1. positive externalities (external benefits)
2. negative externalities (external costs)

Question 8

private costs

Answer 8

paid directly by the producer and consumer in a transaction
e.g. for a producer:
- wages
- rent
- raw materials
for a consumer: price paid for the good/service

Question 9

negative externalities (external costs)

Answer 9

costs to third parties that the market fails to take into account
external costs of production include:
- air pollution
- noise pollution
external costs of consumption include:
- secondhand smoking
- overeating by individuals -> obesity

Question 10

social costs

Answer 10

sum of private costs and external costs

Question 11

external costs of production on a graph

Answer 11

the private marginal benefit (PMB) curve is the demand curve and no external benefits are assumed so it is also the SMB curve
the PMC curve is the supply curve- indicates private costs rise as output rises
equilibrium is where PMB = PMC
SMC curve is to the left of the PMB curve
the socially optimal level of output is where SMB = SMC

Question 12

welfare loss on a graph

Answer 12

the triangle formed where the two equilibrium points meet the point on the SMC curve where free market output meets

Question 13

private benefits

Answer 13

benefits received directly by the producer and consumer in a transaction
e.g. private benefits to a producer = revenue
private benefits to a consumer = utility

Question 14

positive externalities (external benefit)

Answer 14

benefits to third parties that the market fails to take into account
e.g. external benefits of consumption:
- vaccinations preventing disease spreading to others
external benefits of production:
- firms that train workers in computing skills

Question 15

social benefits

Answer 15

sum of private benefits and external benefits

Question 16

external benefits of production on a graph

Answer 16

the PMB curve is the demand curve- indicates private benefits to the consumer decrease as consumption increases
PMC curve is the supply curve and no external costs are assumed so PMC = SMC
SMB curve is to the right of the PMB curve
socially optimal level of output is the equilibrium of SMC = SMB

Question 17

welfare gain on a graph

Answer 17

triangle of the equilibrium points of SMC = SMB and PMB = (PMC + SMC) and the point on the SMB curve where the real output meets

Question 18

public goods

Answer 18

the benefit they provide affects many people
are:
- non-rivalrous (consumption by one person does not limit the consumption of another)
- non-excludable (available for everyone)
opposite of private goods

Question 19

examples of public goods

Answer 19

• street lights
• nuclear defence systems
• national parks

Question 20

the free rider problem

Answer 20

means that once a product is provided, it is impossible to prevent people from using it, and therefore impossible to charge for it

Question 21

information gaps

Answer 21

the free market is based on the assumptions of rational choice and perfect and equal market knowledge
= unrealistic, is usually imbalances in knowledge or a lack of info

Question 22

asymmetric information

Answer 22

where one party has more or superior info compared to another
e.g.
- housing market (estate agents know more than the buyer)