Types of market failure

Question 1

Define market failure

Answer 1

when a market leads to a misallocation of resources and economic/social welfare is not maximsied

Question 2

Types of market failure

Answer 2

externalities, underprovision of public goods, information gaps, monopolies, inequalities in distribution of income/wealth

Question 3

What are externalities

Answer 3

cost/benefit a third party receives from an economic transaction outside of the market mechanism. Negative from demerit, positive from merit

Question 4

What is meant by the under-provision of public goods and why

Answer 4

Public goods are non-excludable (nobody can be excluded from benefiting) and non-rivalorous goods (consumption by one person does not reduce availability to others)

They are underprovided due to the free-rider (where good is underprovided as private sector cannot be sure of profit as people dont need to pay for good) and due to it being difficult to measure the value consumers get from the public good making it hard to put a price on them (consumers undervalue the benefit whilst producers overvalue it so charge more)

Question 5

What are information gaps

Answer 5

When the agents dont have all the information - imperfect or when one has more than the other - asymmetric

Question 6

Monopolises

Answer 6

Due to limited variety of supply, consumers overcharged leading to underconsumption and misallocation of resources as consumers wants aren’t met

Question 7

Inequalities in the distribution of income and wealth

Answer 7

Income = flow of money
Wealth = stock of assets
Negative externalities such as social unrest

Question 8

Complete market failure occurs when

Answer 8

there is a missing market - market does not supply the products at all

Question 9

Partial market failure occurs when

Answer 9

the market produces a good but at the wrong price or quantity so resources are misallocated

Question 10

Private costs are

Answer 10

producer costs production e.g. rent, labour, determines how much the producer will supply

Question 11

Social costs

Answer 11

Private costs + external costs

Question 12

External costs

Answer 12

Difference between social and private costs

Increase disproportionality with increased output

Question 13

Private benefit

Answer 13

Benefit from consumption of good or benefits from firm’s revenue from selling a good

Question 14

Social benefits are

Answer 14

private benefits + external benefits

Question 15

External benefits are

Answer 15

difference between private and social benefits

increase disproportionately as output increases

Question 16

Negative externalities are caused by

Answer 16

demerit goods due to information failures (underestimate costs and so oveconsumed)

Question 17

Positive externalities are caused by

Answer 17

merit goods - information failure as consumers underestimate long run benefits (underprovided in free market)

Question 18

Symmetric information

Answer 18

consumers and producers have perfect market information to make their decision leading to an efficient allocation of resources

Question 19

Asymmetric information

Answer 19

leads to market failure
unequal knowledge between consumer and producer

Modelled by George Akerlof’s market for lemons

Question 20

Imperfect information

Answer 20

information is missing

Question 21

Mobility of labour is

Answer 21

the ability of workers to change between jobs (unemployment shows the inefficiency of labour market)

Question 22

How do governments reduce unequal distribution of income and wealth

Answer 22

progressive tax and government spending on welfare payments (benefits)

Question 23

Private goods are

Answer 23

rivalrous and excludable

Question 24

Quasi (non-pure) public goods

Answer 24

have characteristics of both private and public goods (partially provided by free market) e.g. roads (semi-excludable through tolls and semi-non-rival as multiple consumers can benefit simultaneously unless rush hour)

Question 25

Pension problems

Answer 25

Asymmetric information