Theme 1 - Introduction to Markets and Market Failure (1.3 - Market Failure)

Question 1

What is market failure? [1]

Ref - 1.3.1 (Types of Market Failure)

Answer 1

Price mechanism fails to deliver efficiency, causing a misallocation of resources. [1]

Question 2

State 4 of the possible market failures that can occur. [4]

Ref - 1.3.1 (Types of Market Failure)

Answer 2

Positive/Negative Externalities [1]
Information Gaps [1]
Missing Markets [1]
Factor (e.g. Labour) immobility. [1]

Question 3

State and describe the 2 types of externalities which can occur. [4]

Ref - 1.3.2 (Externalities)

Answer 3

Negative externality [1] - These are negative effects on a third party [1]

Positive externality [1] - These are positive effects on a third party. [1]

Question 4

Describe the difference between private costs and private benefits . [2]

Ref - 1.3.2 - Externalities

Answer 4

PC - A direct internal cost to a consumer/producer. [1]
PB - A direct internal benefit to a consumer/producer. [1]

Question 5

Describe the difference between external costs and external benefits. [2]

Ref - 1.3.2 - Externalities

Answer 5

EC - External costs which are negative effects from third parties. [1]
EB - External benefits which are negative effects from third parties. [1]

Question 6

State the formula used to define social costs and social benefits. [2]

Ref - 1.3.2 - Externalities

Answer 6

Social costs = Private costs + External costs [1]
Social benefits = Private benefits + External benefits [1]

Question 7

Describe the features of an externality diagram. [2]

Ref - 1.3.2 (Externalities)

Answer 7

MPB/MSB on the demand curve. [1]
MPC/MSC on the supply curve. [1]

Question 8

On an externality diagram, where is the social optimum point found? [1]

Ref - 1.3.2 - Externalities

Answer 8

Where MSB = MSC [1]

Question 9

“A negative consumption externality diagram has a….. [2]

Ref - 1.3.2 (Externalities)

Answer 9

….Welfare loss triangle” [1]
….Social optimum quantity below market equilibrium. [1]

Question 10

“A positive consumption externality diagram has a…… [2]

Ref - 1.3.2 (Externalities)

Answer 10

….welfare gain triangle.” [1]
Social optimum quantity above the market equilibrium.” [1]

Question 11

Explain how a negative externality can cause market failure. [4]

Ref - 1.3.2 - Externalities

Answer 11

• When only private costs (MPC) is considered, the output level is at Qe. [1]
• This means there is an overproduction of negative externalities. [1]
• as there would not be a welfare loss triangle if production was at social optimum [1]
• Therefore causing market failure due to overproduction of goods with negative effects on third parties. [1]

Question 12

What are public goods? [1]

Ref - 1.3.3. - Public Goods

Answer 12

A good with non-rivalry and non-excludability characteristics. [1]

Question 13

What are private goods? [1]

Ref - 1.3.3. - Public Goods

Answer 13

A good with rival and excludability characteristics. [1]

Question 14

Give an example of a public and a private good. [2]

Ref - 1.3.3. - Public Goods

Answer 14

Public good - Street lights [1]
Private good - Lamborghini [1]

Question 15

What is the name given to a good which possesses some characteristics of a public good? [1]

Ref - 1.3.3. - Public Goods

Answer 15

Quasi-public good [1]

Question 16

Describe the free-rider problem. [3]

Ref - 1.3.3. - Public Goods

Answer 16

Once a public good is provided [1], it is impossible to prevent economic agents who haven’t paid for it [1], consuming it. [1]

Question 17

“For markets to work effectively, there is a need for…..” [1]

Ref - 1.3.4 - Information Gaps

Answer 17

“…..perfect information for producers and consumers.” (Symmetric information) [1]

Question 18

Why is perfect information important in reducing market failure? [1]

Ref - 1.3.4 - Information Gaps

Answer 18

Allows economic agents to make a rational decision easily. [1]

Question 19

State and describe the difference between asymmetric and symmetric information. [2]

Ref - 1.3.4 - Information Gaps

Answer 19

Symmetric - When all parties have the same amount of information. [1]
Asymmetric - When one party has more information than the other. [1]

Question 20

Using healthcare as an example, describe an example where asymmetric information can cause a misallocation of resources. [3]

Ref - 1.3.4 - Information Gaps

Answer 20

Private healthcare doctors may recommend expensive drugs, [1] which can cause over-spending on these drugs [1], therefore results in irrational consumption. [1]

Question 21

What is the principal-agent problem? [2]

Ref - 1.3.4 - Information Gaps

Answer 21

When the goals of principals (e.g. children) differ from the goals of the agent (e.g. parent) [1], who are making a decision on behalf of the principal. [1]

Question 22

Define labour immobility [1]

Ref - 1.3.5 - Labour Immobility

Answer 22

An inability of workers to take available work, either geographically or occupationally. [1]

Question 23

How does labour immobility cause market failure? [3]

Ref - 1.3.5 - Labour Immobility

Answer 23

Labour immobility causes workers to be less productive [1], so the economy will be producing inside the PPF as there are unused factors of production [1], so this causes a misallocation of resources. [1]

Question 24

Define geographical immobility [1]

Ref - 1.3.5 - Labour Immobility

Answer 24

Inability of workers to take available work in different regions. [1]

Question 25

Define occupational immobility [1]

Ref - 1.3.5 - Labour Immobility

Answer 25

Inability of workers to change occupations to take available work. [1]

Question 26

State and describe 2 factors which can influence geographical immobility. [4]

Ref - 1.3.5 - Labour Immobility

Answer 26

• Lack of affordable rented housing [1] - Higher housing costs means less workers can move into a region. [1]
• Social attachments to a region [1] - e.g. family or other social ties making it unappealing to move. [1]

Question 27

State and describe 2 factors which can affect occupational mobility. [4]

Ref - 1.3.5 - Labour Immobility

Answer 27

Lack of appropriate qualifications [1] - Workers with less transferrable skills find it harder to move jobs. [1]

Lack of affordable training [1] - This means it is harder for workers to gain new skills to enter new jobs. [1]