Theme 1 - Market Failure Flashcards
When does market failure occur?
When the free market mechanism does not lead to an optimal allocation of resources.
What is marginal social cost?
The cost to society of producing an extra unit of good.
What is marginal social benefit?
The benefit that society gains from consuming an extra unit.
What is a demerit good?
A good that brings less benefits to an individual than they realise, such that too much will be consumed under a free ticket.
What is a merit good?
A good that brings unanticipated benefits to consumers such as society believes it will be under consumed in a free market.
What is the information gap?
A situation where some participants have better information about market condition than others.
What are public goods?
A good which is non-exclusive and non-rivalrous.
What are externalities?
A cost or benefit that is external to a market transaction, and borne by a third party.
What are the 3 forms of market failure?
Public goods
Information failure
Externalities
What do externalities lead to and why?
Lead to market failure because the external costs and benefits are not reflected in the market prices under the free market mechanism.
Name the negative externalities.
Pollution
Health
Congestion
Name the positive externalities.
Employment
Recycling
Renewable resources
Why do externalities come about?
Because of consumption or production and therefore affect demand or supply.
Why does the free market fail with externalities?
Because they only consider private costs and benefits.
How do you work out marginal social costs?
Marginal private costs + marginal external costs
How do you work out marginal social benefit?
Marginal private benefit + marginal external benefit
What is marginal external cost?
The cost of production to third parties.
What are marginal external benefits?
The benefits of consumption to third parties.
What are marginal private costs?
The cost to the firm or consumer involved in the private transaction.
What are marginal private benefits?
The benefit to the firm or consumer involved in the private transaction.
What is a asymmetric information?
Where some participants in a market have better information about market conditions than others.
What impact does information failure have on merit goods and demerit goods?
Merit: under-consumed
Demerit: over-consumed
What are the 2 main reasons why information failure occurs?
Lack of shared information: one party withholds important information either before or after an agreement.
Principle agent problem: the seller (the agent) and the buyer (the principle) have different incentives.
What is meant by adverse selection?
It is often the case that those who take insurance are the ones who need it the most, this means the insurance industry faces a skewed market.
Insurance companies deal with it by putting higher premiums on the riskier population.
What are public goods and name the 3 types.
These are non-excludable and non-rivalrous and are also non-rejectable
- non-excludable:not possible to exclude someone from benefitting
- non-rivalrous: once consumed they are still available
- non-rejectable: a person cannot exclude themselves from benefitting from it.
What is a private good and name the 3 types.
Once consumed by someone they cannot be consumed by someone else; such goods are excludable and rivalrous.
- public goods: public transport, traffic lights, defence and the law
- private goods: housing development
- quasi goods (ones that have partial characteristics of a public good): a public bench, healthcare, roads, police.
Explain free-rider problems.
These problems come about once once the goods are provided, public goods are free so there is no way you could ever try to make profit from them because a paying consumer would get the same benefit as a free consumer so there is no incentive to pay.
