Topic 5.2 The meaning of market failure and Topic 5.6 Market Imperfections Flashcards
Market Failure
Market failure occurs whenever there is a misallocation of resources
Partial market failure
When a market exists, but there is a misallocation of resources. This means that the market fails to operate at the social optimum output - allocative efficiency.
Complete market failure
When there is no market whatsoever
Causes of market failure and why
1) Negative externalities
2) Positive externalities
3) De-merit goods
4) Merit goods
5) Public goods
6) Information Failure (asymmetric/symmetric failure)
7) Income inequality
8) Monopolies
9) Factor immobility: if supply can’t meet demand therefore excess demand which means misallocation.
How do Negative and Positive externalities lead to market failure
Due to self-interest, the market operates at the private optimum rather than the social optimum (thus a misallocation of resources)
How do Merit and De-merit goods lead to market failure
This is due to information failure and assymetric information resulting in consumers unaware of the extra benefits/costs their potential action has.
How do public goods lead to market failure
This is due to the free-rider problem (where everyone may not pay their fair share) and firms being profit maximisers so they won’t add benefits to society as isn’t cost effective thus an underprovision of public goods thus a misallocation of resources.
How does information failure lead to market failure
There are 2 types of information failure:
-Absence of symmetric information (where all relevant information is not known by both parties)
- Assymetric information (one party knows more than the other).
Without full information about a product it is difficult for consumers/producers to make decisions regarding price, quantity etc. thus leading to a misallocation of resources.
How does Income inequality lead to market failure
Income inequality is inequitable (unfair) and can lead to things such as social unrest, riots etc which are negative externalities.
How do monopolies lead to market failure.
Since the consumer doesn’t have much choice with monopolies, they have to pay the higher price and are often overcharged thus leading to underconsumption. This is allocatively inefficient as it doesn’t meet the consumers needs and wants to maximise social welfare.
How does factor immobility lead to market failure
If the market mechanism cannot respond to an increase in demand, then they may not be able to increase their supply which causes excess demand, a misallocation of resources and market failure.
