Topic 5: Market Failure

Question 1

Define market failure

Answer 1

Occurs when resources are not allocated efficiently- in other words, total economic surplus is not being maximized

Question 2

Define a competitive market

Answer 2

A competitive market is one characterised by a large number of small firms, free entry and exit and very little product differentiation
When one or more of these conditions is not met the market is said to be imperfect

Question 3

When does an imperfect market exist?

Answer 3

An imperfect market exists when
- There are a relatively small number of firms
- Firms have market power
- Firms use product differentiation
- Barriers to entry are used to restrict competition

They set prices and prices are usually higher and reduced output due to less competition

Question 4

Define a monopoly

Answer 4

Monopoly is a market with just one firm (Synergy and Australia Post are government regulated monopolies)

Question 5

Define an Oligopoly

Answer 5

Oligopoly is a market with a few dominant firms (Coles and Woolworths dominate grocery market)

Question 6

Define barriers to extry + example

Answer 6

A barrier to entry is anything that restricts or blocks the entry of new firms into an industry or market – key in imperfect markets
eg. Government regulations, technology barriers, start up costs

Question 7

When does a firm have market power?

Answer 7

A firm has market power if it can affect the market price by varying its output

Question 8

When will a competitive market produce?

Answer 8

A competitive market will produce where demand equals supply
Equilibrium price and quantity is efficient
Total surplus (sum of consumer and producer surplus) is maximised

Question 9

Define anti competitive behaviours

Answer 9

Anti-competitive behaviour refers to any agreements or arrangements between firms that seek to restrain competition and thereby remove the automatic regulation that competitive market achieve

Question 10

What is the CCA act

Answer 10

This act is administered by the Australian Competition and Consumer Commission (ACCC) and contains rules against anti-competitive conduct to ensure that there is fair and effective competition within Australia
Act also contains consumer protection rules – known as Australian Consumer Law

Question 11

What is the role of the ACCC?

Answer 11

Role of ACCC is to protect, strengthen and supplement the way competition works in Australian markets and industries to improve the efficiency of the economy and increase welfare of Australians

Question 12

What types of regulations reduce competition?

Answer 12

The types of regulation that restrict competition are those that:
- Limit the number or types of businesses
- Limit the ability of business to compete
- Reduce incentive for businesses to compete
- Limit the choices and information available to consumers
eg. Taxi market

Question 13

Define externalities

Answer 13

The side effects of economic activity, when they exist , the market fails

Question 14

Define negative externalities

Answer 14

When economic actions from either production or consumption create an external cost, it is referred to as a negative externality and will cause the market quantity to be greater than the optimal quantity and will cause the market price to be less than the optimal price

Question 15

Example of a negative externality

Answer 15

Usind the freeway:
a private decision many motorists make each day
Make this decision by weighing up costs and benefits – includes cost of petrol, travel time, convenience
The economic action of driving on the freeway imposes a cost on other motorists – an externality – car adds extra congestion experienced by all other cars - increased congestion adversely affects other motorists – it imposes an external cost or externality on other drivers

Question 16

Define positive externalities

Answer 16

Create an external benefit for the third parties

Question 17

Example of a positive externality

Answer 17

GYM:
- The membership fee gives the consumer the right to use equipment and get advice
- First and second parties are the buyer and seller
- A number of third parties also benefit – for example the consumers employer
- A healthy, fit worker is more likely to be productive

Question 18

Why does externalities occur?

Answer 18

In the case of environmental externalities such as pollution, the problem is a lack of property rights
Who owns the atmosphere or the oceans?
Property rights define the ownership and use of a resource
Many environmental resources are open access resources – they are not privately owned
These resources do not have a price to restrict their use like a private good
Free goods such as the environment will be overused and exploited
People can use these resources without paying for them
There is no incentive to use these resources in a socially optimal way

Question 19

Government policy on negative externalites

Answer 19

In the case of a negative externality, a tax should be placed on the producer to reduce output

Question 20

Governemnt policy on positive externalities

Answer 20

In the case of a positive externality (education), a subsidy should be used to increase output

Question 21

Define rival?

Answer 21

Does the consumption by one person reduce the supply available to other users?

Question 22

Define excludable

Answer 22

Is it possible to exclude a non-payer from consuming the good or service?

Question 23

Define private goods + example

Answer 23

Private goods are rival and excludable
eg. food, cars,movie tickets

Question 24

Define club goods + exanple

Answer 24

Nonrival in consumption and excludable, can be comsumed collectively by a large number of people
eg. netflix, disney +

Question 25

Define Public good + example

Answer 25

Non-excludable, non-rival
eg. Footpath, can’t exclude anyone and using it will not deminish anyone else from using it.

Question 26

Define common resources + example

Answer 26

Non-excludable and rival
Example:
The ocean and atmosphere
Ownership is universal – there are no clearly defined private property rights
Cannot be priced
Fishing – no price tag – they are free
Encourages people to consume as many as they can

Question 27

Define tragety of commons

Answer 27

An economic problem that results in overconsumption and the depletion of a resource that is mutually shared

Question 28

COVID and market failure

Answer 28

• With infectious diseases, an individual’s actions affects other peoples wellbeing – externalities
• Lack of social distancing by one person creates a negative externality because there is a higher risk of infection for all
• Economic theory suggests the government should impose penalties on those creating a negative externality as an incentive to change their behaviour – fine for not wearing masks when required
• Positive externalist is becoming vaccinated against COVID-19
• Private benefit of self protection but also create an external benefit for others as they reduce the risk of infection
• This is why the COVID-19 vaccine was made free – the social benefit is greater than the cost

Question 29

Climate change and market failure

Answer 29

• It involves global negative externalities in both production and consumption and involves the overuse of a common resource – the atmosphere
• Every country produces carbon emissions
• These emissions impose external costs on everyone
• To solve global warming, every country would need to reduce their emissions and switch to a cleaner technology or a non-carbon based emission
• One solution favoured by economists is a carbon tax
  This would increase the price of using fossil fuels and provide incentives for both producers and consumers to seek cleaner alternatives