Theme 1 Market Failure and Gov Intervention Flashcards
what is market failure
when the free market leads to an inefficient allocation of resources.
what is an externality + e.g.
a positive or negative effect on a third party who was not involved in the transaction. e.g. a smoker buys cigarettes, the third party negatively affected is the passive smokers
define private costs
ones that are borne by the buyer or seller in the transaction
define external costs
costs to a third party, e.g. noise pollution to local residents who live under the Heathrow flight path
give two examples of external costs in the production of a pencil
cutting down trees may affect wildlife and the environment, transporting the pencil creates pollution and can cause congestion
define external benefits
benefits to a third party not involved in the transaction e.g. the result of someone not getting COVID because of someone else’s vaccination
define social costs
private costs + external costs
define social benefits
private benefits + external benefits
define and give e.g. of merit good
one with a positive externality in consumption e.g. education, vaccinations and healthy living.
define and give e.g. of demerit good
one with negative externality e.g. smoking gambling and drinking
in what way are externalities case of market failure
they mean that the free market equilibrium is different from the socially optimum equilibrium. This deviation from the optimum means that some goods are either over or under produced and consumed leading to an inefficient allocation of resources which is our definition of market failure
what are missing markets
markets for goods that are not provided due to profitability problems caused by the free-rider problem
define and give examples of public goods
Public goods are ones which are non-excludable and non diminishable such as street lights, defence, and light houses, national parks. - Non-excludable means that anyone can access the product even if there are some paying consumers, this is the free-riding problem. Non-diminishable means that one person using the product doesn’t mean every other person can’t, no finite supply, these factors means that private firms are not able to charge for these products and so do not provide them.
what is the difference between a merit good and a public good
a merit good has positive externalities in consumption and is under-consumed in the free market, whereas a public good is non-rivalry and non-excludable and not provided at all in a free market economy (missing market) due to the free rider problem.
three external costs of production
air and noise pollution, pollution caused from congestion in transporting the good, pollution from deforestation.
three external consumption benefits
1 education causes society to be better off 2 vaccine means other people cannot get from u 3 healthy lifestyle eases NHS costs also safety in public
what is the free rider problem
once a product is provided it is impossible to prevent use therefore impossible to charge for it.
what is a case of asymmetric information
when one party in a transaction has more information than another e.g. the doctor, you wont refute the doctors claim that you need a medicine as they know sm more than you. Life insurance is another example as the provider doesnt know how reckless the consumer will be, this is known as moral hazard (the user will be more risky knowing the provider will incur the cost of any damage)
how does imperfect market info lead to a misallocation of resources
parties without complete information will make choices that may not be rational given the actual scenario
adv and dis of indirect taxes as gov intervention
adv: incentive to reduce external cost e.g. pollution, source of revenue for gov with only a few administrative costs.
dis: ineffective in reducing pollution if demand is price inelastic, difficulty of setting appropriate tax due to difficulty in quantifying external cost.
adv and dis of subsidies as gov intervention
adv: reduction in cost of production enables producers to lower price, incentive for people to increase consumption.
dis: massively costly to the government and therefore taxpayer including subsidy and administrative costs, firm becomes reliant on subsidy and therefore reduces efficiency, ineffective if demand is inelastic, difficult setting as difficult quantifying external benefit.
maximum price adv and dis
adv: enables consumers on lower incomes to afford product, helps prevent inflation. dis: shortages producers may exit market for another more profitable market, if the gov subsidises the firm to encourage them to maintain output, huge cost to gov and tax payers, with increased demand there may be shortages leading to a black market or some consumer being unable to find the good.
Tradebale pollution permits
Issued by the government to firms which limits pollution anything more involves fines. The permits can be sold and bought through the market mechanism, an incentive for firms to reduce pollution. Low administrative costs to set up these schemes
Dis: pollution continues and large efficient firms can buy up the permits and continue to pollute.
Provision of info
Gaps may be closed by articles on the internet or packaging which is designed to inform consumers about issues concerning products e.g. smoking risks, sugar levels.
Regulation
Examples: complete bans on production and sale of a good or service, limits on production or pollution, regulations relating to consumption e.g. a buy limit or smoking zones.
Adv: can limit the extent of the activity, can act as an incentive for producers to innovate around the bad activity.
Dis: cost of enforcement e.g. inspectors, problem with determining suitable regulations
Gov failure def
Intervention that results in a net welfare loss
Causes of government failure
ICAUSE
Inadequate info, conflicting objectives, administrative costs, unintended consequences, self interest, expertise (lack of)
minimum price adv and dis
adv: producers know in advance of the guaranteed price, creates greater certainty for investment and output.
dis: if min price is set too high there will always be surpluses, as the gov buys and stores this it is costly to gov and tax payers, encourages over production therefore potentially causing net welfare loss.
