Topic 4: Market Failure Flashcards
Define “Market failure”
If left up to the market (Laws of demand and supply) at the point of equilibrium there will be a misallocation of resources. Resources can either be over or under allocated.
What does market failure lead to?
- Under-consumption or Over-consumption of “good” products (too little).
- Under-consumption or Over-consumption of “bad” products (too much).
Overall there is a net social welfare loss.
What are the two types of market failures?
- Lack of competition (partial market)
- Complete missing market.
What does “Lack of competition” mean?
Partial market failure occurs when the market does actually function but it produces either the wrong quantity of a product or at the wrong price. There is a information failure so its either overproduced or underproduced. Firms are profit maximisers so they aren’t interested in effects on society.
What does “Complete missing market” mean?
Where a good or service is wanted but there is no firm supplying goods to satisfy the demand. (supply = 0). Missing market tend to occur when a good or service provides a collective benefit to the third party. However, firms don’t receive any revenues to supply this product as its difficult to get people to pay (free rider problem).
Name two reasons why market failure occurs?
- Externalities.
- Information Failure.
What is meant by “externalities”?
Self interest, firms or consumers do not take into account impact on other groups. Consumers only want to max utility whilst firms want to max profits and minimise costs. This leads to over or under production or consumption.
What is meant by “Information failure”?
When people have inaccurate, incomplete, uncertain or misunderstood data and so potentially wrong choices are made. This affects the willingness of both the consumers and producers. Consumers can make rational decisions due to being bombarded with too much info. They may not have time or expertise (bounded rationality) to decipher the info correctly.
Define “Tragedy of commons”
Self interest leads to over production
As no single individual (firm or government) owns the resource it will lead to overproduction and exploitation of the scarce resource until it is completely used and depleted.
Define “Monopoly power”
One dominant seller or producer
They tend to under produce leading to under consumption and underproduction
Prices are also higher which again leads to under consumption.
Define “Public goods”
Free rider problem and profit motives of the firm. This is due to non excludability. As a result there is a complete missing market ie NO PRODUCTION of a product that generates positive externalities.
What is meant by “externalities”?
Externalities are spillover effects. Externalities lie outside the initial market transaction / price, they only affect third parties. Externalities can be positive and/or negative. Externalities cause market failure.
What is meant by “private costs”?
These are also known as INTERNAL COSTS to the individual consumer who buys/ consumes the product and / or the individual firm who sells and produces the product.
What is meant by “external costs”?
These are costs to third party or spillover effects from the consumption and production of goods and services.
Other groups of people are affected by the transaction.
What do the existence of externalities create?
Creates a divergence between private and social costs of production.
Private costs + External costs create what?
These are costs to society as a whole. It’s the costs to those consuming and producing the product and the costs to the third party.
What is meant by “Private benefit”?
Benefits to the individual consumer who buys/ consumes the product and the individual firm who sells and produces the product
They are the benefits gained by the producer or consumer directly involved in a transaction.
