Types of Market Failure

Question 1

Market Failure

Answer 1

Whenever the free market mechanism fails to allocate resources efficiently, resulting in a social welfare loss

Question 2

How does an inefficient allocation of resources occur

2

Answer 2

When the output of goods isn’t PRODUCTIVELY EFFICIENT. Happens when firms are not producing at lowest possible AC

When the output of goods isn’t ALLOCATIVELY EFFICIENT . This is when a good is over/underproduced i.e. if Price is less than Marginal Cost it is overproduced & vice versa.

Question 3

Externalities

Answer 3

Refers to the positive / negative consequences of economic activity on a 3rd party or society not involved in the economic transaction… often leads to partial market failure

e.g. A firm dumps their hazardous waste in a pit, then this affects a fish farm down the river as the water is contaminated. This cost is not reflected in the price of the good, thus it is overproduced

Question 4

Missing Market

Answer 4

When the market cannot provide a good or service that is demanded

i.e. Public Good such as Street Lights. Public goods are consumed collectively by society, regardless if you have paid for it or not. It would be impossible to construct a market where people choose how much streetlights to pay for. This is the ‘free rider problem’

Question 5

Asymmetric Information

Answer 5

When one party involved in an economic transaction holds greater knowledge than the other, often producer has better knowledge than the consumer, therefore can charge higher prices

Question 6

Partial Market Failure

Answer 6

Where a good is supplied, but is over/under-produced