topic8: market mechanism, market failure and government intervention in markets Flashcards
what does the price mechanism determine
price
3 main functions to allocate resources the price mechanism uses
rationing- when there are scarce resources price increases due to the excess of demand and discourages demand
incentive- encourages change in behavior of a consumer or producer
signaling- price acts as a signal to consumers and new firms entering the market
advantages of price mechanism
- allocativley efficient
- no time cost ( no one needs to be paid to monitor it)
- process is efficient bcs prices are as low as possible
- consumers have control over what producers make
disadvantages of price mechanism
- may be inequality in income and wealth
- will be missing markets for goods
- some goods objectively should not be produced through it
- no moral overlay or beliefs before government intervention
when does market failure occur
misallocation of resources
types of market failure
- externalities
- the under privison of public goods
- information gaps
- monopolies
- inequalities in distribution if income and wealth
when does complete market failure occur?
when there is a missing market
when does partial market failure occur
when a market produces a good but it is the wrong quantity or the wrong price (misallocation of resources)
what are public goods
- missing from the free market
- non excludable (leads to free rider problem)
- under provided
- provided by the government
what are private goods
- rival
- excludable
what are quasi public goods (non pure)
- have characteristics of both public and private goods. partially provided by the free market
what is the tragedy if commons
- how individuals prioritise personal gain over the wellbeing of society
what does it mean when resources are held in common
noone owns the resource but everyone can acess it
what is an externality
a cost it benefit a third party receives from an economic transaction outside of the market mechanism
what 2 things can externalities be
positive- caused by merit goods
negative- caused by demerit goods
what are private costs
the direct costs that producers or businesses pay to create a product it service or the market price consumers pay as it reflects the producer costs
what are social costs
the total costs of an economic activity combining private costs and external costs
how are external costs depicted
the verticle distance between the 2 curves ( typically the MPC and MSC)
what does private benefit refer to
for consumers - the satisfaction they get from comsuming the good
for firms - revenue earned
what is social benefit
the total benefit to society from an economic activity including private benefits and external benefits
social output is where..
MSC=MSB (maximum point of welfare)
the output where social costs > private costs is known as the area of
deadweight welfare lose
with negative externalities what is the supply
MSC > MPC
the output where social benefits > private benefits is known as the area of
welfare gain
what is the absence of property rights
it is not clear who owns what
why the absence of property rights leads to externalities
- markets become inefficient where there are no property rights ( free riders can have unlimited acseess)
- the moral hazard assumes someone else eill pay for the consequences of a poor choice
- scarce resources could be over used or exploited
symmetric information
consumers and producers have perfect market information to make their decision. this leads to efficient allocation of resources
asymmetric information
when there is unequal knowledge between consumers and producers. leads to market failure
imperfect information
where information is missing so an informed decision cannot be made
principal - agent problem
when the agent makes decisions for the principal but the agent is inclined to act in their own interest rather than those of the principal. linked to asymmetric information
the mobility of labour
the ability of workers to change between jobs
frictional unemployment may exist while
people move between jobs and search for new ones
structural unemployment occurs when
there is a decline in an industry. thus can mean workers skills do not match the location and skills required for the job
the geographical immobility of the factors of production refers to
the obstacles which prevent the factors of production moving between areas
the occupational immobility of the factors of production refers to
the obstacles that prevent the factors of production changing there use
the basic model of monopoly suggests
that higher prices and profits and inefficiency may result in a misallocation of resources compared to the outcome in a competitive market
consumer surplus
difference between what a consumer is willing to pay for a good or service and what they actually pay
producer surplus
the difference between what a producer receives for a good or service and the minimum amount they are willing ti accept to produce that good or service
what does the uks compettiton policy aim to reduce
the amount of anti competitive behavior in markets to protect consumers ( undertaken by the CMA)
why do governments encourage competiton
leads to lower prices , higher quality of goods, improvements in technology
what is the red tape challenge
aim to simplify regulation for businesses especially aimed towards small businesses. aims to make it cheaper and easier to meet environmental targets and create jobs
what is the idea of creative destruction schumpeter proposed
new entrepreneurs are innovative which challenges existing firms. the more productive firms then grow whilst the least productive are forced to leave the market. this results in an expansion of the economys productive potential
deregulation
the act of reducing how much an industry is regulated. it reduces government power and enhances competition
privatisation
assets are transferred from the public sector to the private sector
nationalisation
when a private sector assests are sold to the public sector
regulatory capture happens when
regulators instead of protecting consumer interests act in the interest of companies they oversee. this can happen when they rely heavily on information provided by these companies leading to bias or influence
what does indirect tax do
its spent on expenditure so they increase the production costs for producers so producers supply less. this increases market price and demand contracts. they can be used to discourage the production or consumption of a demerit good
2 types of indirect tax
- ad valorem
- specific tax
ad valorem
are taxes such as VAT which adds 20% of the unit price (the main indirect tax in the UK)
government revenue from ad valorem taxes is larger if the demand is price elastic or inelastoc
inelastic bcs demand falls only slightly with tax
specific taxes
set tax per unit
supply curve shift when ad valorem tax is added
the supply curve pivots or rotates upwards due to the tax being a percentage of the price.as the price of the good rises the amount of tax also increases making the curve steeper as price levels rise
supply curve shift when specific tax is added
the entire supply curve shifts vertically upwards by a fixed amount equal to the tax. This is because the tax is set amount per unit regardless of the price
what is a subsidy
a payment from the government to a producer to lower their costs of production and encourage them to produce more.
they encourage the consumption of merit goods. this includes the full social benefit so the external benefit is internalised
do consumers gain more from the subsidy is the demand is price inelastic or elastic
inelastic
why are maximum prices set
where the consumption or production of a good is to be encourages so the good does not become too expensive to produce or consume
where are maximum prices set price wise
below the free market price or they are ineffective
benefits of maximum price
-prevents monopolies from exploiting consumers
-could lead to welfare gains for consumers by keeping prices low and could lead to efficieny bcs they have an incentive to keep their costs low to maintain a profit level
disadvantages of macimum price
- control the market price so could lead to government failure if they misjudge where the optimum market price should be
- could reduce a firms profits which could lead to less investment in the long run
- firms might increase the price of other goods so consumers might have no net gain
why might the government set a minimum prive
where the consumption or production of a good is to be discourages
tradeable pollution permits
limit the amount of negative externalities in the form if pollution created in industries.their permits can be traded
state provision of goods
governments role in providing goods and services that are non excludable and non rivalous
government intervention to target market failure
-indirect taxes
-subsidies
- maximum and minimum prices
- tradeable pollution permits
- state provision of public goods
- provision of information
- regualtion
causes of government failure
- distortion of price signals- market mechanism cant act freely cos of subsidies
-unintended consequences-inffective - high administrative costs
- imperfect information
