Theme 1 Market Failure and Gov Intervention

Question 1

what is market failure

Answer 1

when the free market leads to an inefficient allocation of resources.

Question 2

what is an externality + e.g.

Answer 2

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

Question 3

define private costs

Answer 3

ones that are borne by the buyer or seller in the transaction

Question 4

define external costs

Answer 4

costs to a third party, e.g. noise pollution to local residents who live under the Heathrow flight path

Question 5

give two examples of external costs in the production of a pencil

Answer 5

cutting down trees may affect wildlife and the environment, transporting the pencil creates pollution and can cause congestion

Question 6

define external benefits

Answer 6

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

Question 7

define social costs

Answer 7

private costs + external costs

Question 8

define social benefits

Answer 8

private benefits + external benefits

Question 9

define and give e.g. of merit good

Answer 9

one with a positive externality in consumption e.g. education, vaccinations and healthy living.

Question 10

define and give e.g. of demerit good

Answer 10

one with negative externality e.g. smoking gambling and drinking

Question 11

in what way are externalities case of market failure

Answer 11

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

Question 12

what are missing markets

Answer 12

markets for goods that are not provided due to profitability problems caused by the free-rider problem

Question 13

define and give examples of public goods

Answer 13

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.

Question 14

what is the difference between a merit good and a public good

Answer 14

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.

Question 15

three external costs of production

Answer 15

air and noise pollution, pollution caused from congestion in transporting the good, pollution from deforestation.

Question 16

three external consumption benefits

Answer 16

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

Question 17

what is the free rider problem

Answer 17

once a product is provided it is impossible to prevent use therefore impossible to charge for it.

Question 18

what is a case of asymmetric information

Answer 18

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)

Question 19

how does imperfect market info lead to a misallocation of resources

Answer 19

parties without complete information will make choices that may not be rational given the actual scenario

Question 20

adv and dis of indirect taxes as gov intervention

Answer 20

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.

Question 21

adv and dis of subsidies as gov intervention

Answer 21

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.

Question 22

maximum price adv and dis

Answer 22

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.

Question 23

Tradebale pollution permits

Answer 23

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.

Question 24

Provision of info

Answer 24

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.

Question 25

Regulation

Answer 25

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

Question 26

Gov failure def

Answer 26

Intervention that results in a net welfare loss

Question 27

Causes of government failure

Answer 27

ICAUSE
Inadequate info, conflicting objectives, administrative costs, unintended consequences, self interest, expertise (lack of)

Question 28

minimum price adv and dis

Answer 28

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.