Theme 1: Market Failure

Question 1

What is market failure?

Answer 1

When the price mechanism leads to a misallocation of resources

Question 2

What are the 4 types of market failures?

Answer 2

1) negative externailities
2) positive externalities
3) public goods
4) information gap

Question 3

What is another word for negative production externalities?

Answer 3

External costs

Question 4

What are the 2 things you find inside the price mechanism?

Answer 4

Private costs and private benefits

Question 5

What are the 2 things you find outside the price mechanism?

Answer 5

External costs and external benefits

Question 6

What is the formula for social cost?

Answer 6

Private costs + external costs = social cost

Question 7

What’s the formula for social benefit?

Answer 7

Private benefits + external benefits = social benefit

Question 8

For a negative production externaility what 3 components would there be in the graph?

Answer 8

MPC, MPB, MSC

Question 9

Where do we want to stop and actually stop in a negative production externality?

Answer 9

Want: MSC = MPB
Actually: MPC = MPB

Question 10

What is the point called when MSB = MSC

Answer 10

Social efficient equilibrium

Question 11

What is the social efficient equilibrium?

Answer 11

A point where society’s welfare is maximized

Question 12

Draw 2 types of negative production externality graphs:

Answer 12

Question 13

What is a negative production externality?

Answer 13

When the production of a good creates costs to third parties outside the price mechanism

Question 14

What is a negative consumption externality?

Answer 14

When the consumption of a good creates costs to third parties outside the price mechanism

Question 15

What are the 4 ways to reduce negative production externalities?

Answer 15

1) Taxes
2) Tradable pollution permits
3) Minimum prices
4) Regulations

Question 16

What are tradeable pollution permits?

Answer 16

Permits which allow firms to pollute up to a certain limit. These permits can then be traded between firms

Question 17

Example of a tradable pollution permit?

Answer 17

Europe’s emissions trading scheme (ETS). The EU government set a cap of 2B tonnes of CO2, and issued permits to firms. It held the last 10% of permits back for auction

Question 18

Can you draw a tax to internalize a negative production externality?

Answer 18

Question 19

What is minimum price?

Answer 19

The lowest price a good can be legally sold for

Question 20

Can you show a graph of a minimum price

Answer 20

Question 21

Can you give an example of a minimum price

Answer 21

Scotland’s minimum price on alcohol is 50p per unit of alcohol

Question 22

What does regulation mean?

Answer 22

When the government makes changes to the law to address market failure

Question 23

Example of regulation?

Answer 23

The firearms act which made it illegal to buy a handgun in the UK

Question 24

What is another name for positive consumption externalities?

Answer 24

External benefits

Question 25

What are positive externalities?

Answer 25

Benefits which affect third parties outside the price mechanism

Question 26

Where do we want to stop and actually stop in a positive consumption externality?

Answer 26

Want to stop: MSB = MSC Actually stop: MPB = MSC

Question 27

What are the 2 ways to solve positive externalities

Answer 27

1) subsidy 2) max prices

Question 28

What is maximum price?

Answer 28

The highest price supplies of a good can sell for

Question 29

Draw a maximum price graph

Answer 29

Question 30

Draw a subsidy being implemented in the positive consumption externality

Answer 30

Question 31

What are public goods?

Answer 31

Goods which are non-excludable and non-rival

Question 32

What are private goods?

Answer 32

Goods which are rival and excludable

Question 33

What does non-excludable mean?

Answer 33

When you can’t exclude others from consuming your good

Question 34

What does non-rival mean?

Answer 34

Your consumption of the good does not prevent anyone else from using it

Question 35

What is the free rider problem? (Give 3 things)

Answer 35

- When consumers wait for others to buy and free-ride, no one demands the public good. - Also producers wont supply public goods because they can’t make profit. - So public goods are underprovided by the market

Question 36

How does the government intervene to solve the free-rider problem?

Answer 36

By using state provision of flood defenses and streetlights

Question 37

Evaluation for public goods

Answer 37

In real life, public goods aren’t completely non-excludable and non-rival

Question 38

What is state provision?

Answer 38

When the government provides a good

Question 39

What are the 2 types of information gaps?

Answer 39

1) incomplete information 2) asymmetric information

Question 40

What is incomplete information?

Answer 40

When someone doesn’t have full information about the benefits or costs of their decisions

Question 41

How does the government intervene with underconsumption (incomplete information)? (Give 3 ways)

Answer 41

1) regulation 2) providing information 3) subsidies

Question 42

How does the government intervene with overconsumption (Incomplete information)? (Give 3 ways)

Answer 42

1) regulations 2) advertising 3) specific taxes

Question 43

What is asymmetric information?

Answer 43

When one party knows more than another party in a transaction

Question 44

What are information gaps?

Answer 44

When consumers or producers lack the information needed to make an informed decision