THEME 1, Market failure (1.3) Flashcards
What is marginal private benefit? MPB
- The benefit from an additional unit of a good or service that the consumer of that good or service receives.
What is marginal private cost? MPC
- The cost of producing an additional unit of a good or service that is borne by the producer of that good or service
What is market failure?
- Failure to allocate scarce resources in the best or optimum way
- NET WELFARE LOSS
What is complete market failure?
- When a market fails to supply any of a good which is demanded, creating a missing market
What is a negative externality?
- The imposing of a cost on a party as a negative indirect effect of the actions of another party.
What is a positive externality?
- A benefit received or transferred to a party as an indirect effect of the transactions of another party.
What always happens in a market with a negative externality?
- Supply exceeds demand
- Too much is produced.
Define the term external benefits.
When the social benefit of an economic action is greater than the private benefit
How are external benefits calculated?
External benefits = Social benefits - Private benefits
How can externalities cause market failure?
- If the price mechanism does not account for the social costs and benefits of production and consumption
What are negative externalities caused by?
- Demerit goods
- Usually over provided
- For example, cigarettes and alcohol are demerit goods.
What are positive externalities caused by?
- Merit goods
- Usually under provided in a free market
- For example, education and healthcare
How are social costs calculated?
- Private costs + external costs
How are external costs shown on a diagram?
- The vertical distance between the two
curves. - Between private costs and social costs
How are external benefits shown on a diagram?
- The difference between private and social benefits.
- The vertical distance between the two
curves.
Where is the social optimum position?
- MSC = MSB
What is the social optimum position?
- The point of maximum welfare.
Where is the welfare loss found on an external costs of production diagram?
- The output where social costs > private benefits
Where is the welfare gain found on an external benefits of production diagram?
- The output where social benefits > private costs
What are government policies to reduce negative externalities?
- Indirect taxes to increase the cost of demerit goods
- Subsidies to encourage the consumption of merit goods.
- Regulation to enforce less consumption of a good. For example, the minimum school leaving age.
- Provide the good directly
- Personal carbon allowances
- Minimum set prices
When is the ban of a good useful (ONLY?
- Bans are only useful where MSC > MPB
- (the MSC curve is above MPB)
Are externalities in market transactions?
No
Where is market equilibrium on an externalities diagram?
- MPB = MSC
Definition of external benefits
- Positive third party effects
- The difference between private and social benefits.
How is MSC calculated?
- MSC = MPC + MEC
What is MEC?
- Marginal external cost
What are the three types of market failure?
- Externalities
- Under-provision of public goods
- Information gaps
What are external costs?
- Costs incurred by an individual or community as a result of an economic transaction which they are not directly involved in.
What are mixed externalities?
When production and/or consumption leads to both external costs and benefits
Example of mixed externality
- Agricultural Pesticide Usage
- Use of automobiles in congested urban areas
What are qualities of public goods?
- Non-rivalry
- Non-excludable
- Underprovided by the private sector due to the free-rider problem.
Example of public goods
Streetlights
What is a merit good?
A good with external benefits, where the benefit to society is greater than the benefit to the individual
What is a demerit good?
A demerit good is a good with external costs, where the cost to society is greater than the cost to the individual.
By the free market, are demerit goods over or under provided?
Over-provided
By the free market, are merit goods over or under provided?
Under-provided
What does non-rivalry mean in the context of public goods?
One person’s use of the good doesn’t stop someone else from using it
What does non-excludable mean in the context of public goods?
You cannot stop someone from accessing the good and someone cannot chose not to access the good.
What is the free rider problem?
You cannot charge an individual a price for the provision of a non-excludable good because someone else will gain the benefit from it without paying anything.
Will the private sector produce public goods?
- No
- They cannot be sure of making a profit, due to the non-excludability of public goods.
Why does only the government produce public goods?
If the provision of public goods was left to the market mechanism, the market would fail and so they are provided by the government
What is symmetric information?
- When buyers and sellers have potential access to the same information
What is asymmetric information?
- When one party has superior knowledge compared to another.
- They can take advantage of the other party
Examples of information gaps
- Drugs - where users do not see the long term problem
- Pensions - where young people do not see the long term benefits of paying into their pension schemes
Are carbon permits a type of tax?
NO
What is a quasi-public good?
Have characteristics of both private and public goods, including partial excludability, partial rivalry, partial diminishability and partial rejectability
Examples of quasi-public goods:
- Roads
- Tunnels
- Bridges
Arguments for state provision of a public good
- Avoids free-rider problem
- Funding is shared equitably
- Ensures necessary goods are provided
- Social optimum will be reached
Arguments against state provision of a public good
- State provision is often inefficient
- Opportunity costs
- Government failure could happen
Examples of merit goods
Education, Healthcare
Examples of demerit goods
Smoking, Cigarettes, Unhealthy food
How do information gaps lead to market failure?
- Misallocation of resources because people do not buy things to maximise their welfare
Examples of something that can lead to information gaps:
- Unreliable information
- Hidden information
- Advertising
When is there an economic case to ban a product?
- When the quantity at the social optimum is ZERO
Examples of regulations
- Driving: MOT, license
- Alcohol: Age
- Tobacco: Age, flavour
Advantages of regulation
- Can be effective at preventing market failure
- Can create positive externalities
- Potentially quick to implement
- Can be used alongside other policies
Disadvantages of regulation
- Bureaucracy / enforcement can be costly and time consuming
- Raises business costs to comply, reducing competitiveness
- May be misguided due to poor GOVt information
- Risk of regulatory capture
What is regulatory capture?
- When a regulator acts in the interests of the producer rather than the consumer
- Regulator is often reliant form the information from the producer (asymmetric information)
What are problems w subsidies?
- Opportunity cost
Why does the subsidy correct market failure?
- By introducing a subsidy equal to the positive externality, we are effectively internalising it.
- Producers are incentives to produce at Q*, social optimum
Disadvantages of carbon permits
- Corruption
- Difficulties avoiding a volatile carbon price
- Pollution may be shifted offshore
- If industry is highly profitable, impact may be minimal
ALL Causes of Market Failure
- EXTERNALITIES
- FACTOR IMMOBILITY
- ASYMMETRIC INFORMATION
- PUBLIC GOODS
- DEMERIT GOODS/ MERIT GOODS
- CONCENTRATED MARKETS
What is monopoly power?
When one firm dominates the market with more than 25% market share,
the firm has monopoly power.
What are common pool resources?
- Non excludable but rival
Examples of common pool resources
- Deep sea fish stocks
- Grazing lands
How can you judge the significance of a market failure?
- Size of the externality
- Numbers affected
- Severity of the impact
- Time frame
- Ease of correction / likelihood of success
- Will it worsen?
- In how many ways will the market fail? (number of market failures)
- How many interventions are there already
What are the 6 examples of GOVt failure?
- Policy that leads to greater inequality
- Regulatory capture
- Failure to rigorously test a policy
- Conflicts with other policy aims
- Unintended consequences
- High enforcement costs
Advantages of tradable pollution permits
- Market based solution
- Incentive to reduce pollution
- Pollution is controlled by authorities
- GOVt revenue
