Unit 3: Market Failure Flashcards
Define market failure
When the free market mechanism does not lead to an efficient allocation of resources
Define efficient
When total welfare is maximised given current resources
Define externality
When the consumption of a good/service has effects on something/someone not involved in the transaction
Define consumption externality
An externality that affects the consumption side of a market, which may be positive or negative
Define production externality
An externality that affects the production side of a market, which may be positive or negative
Define private cost
A cost borne by a party in a transaction
Define external cost
A cost that is borne by a third party and not reflected in market prices
Define private benefit
A benefit received by a party when producing/consuming a good
Define external benefit
A benefit which is received by a third party and is not reflected in market prices
How is social cost calculated?
Private cost + external cost
Define marginal social cost
The cost to society of producing an extra unit of a good
Define a demerit good
A good with a negative externality in consumption
Define free market output
where marginal private benefits = marginal private costs with no government intervention
Define socially optimum output
where marginal social benefits = marginal social costs and societies welfare is maximised
Define a private good
A good that, once consumed by one person, cannot be consumed by someone else
Define a public good
A good that is non-excludable and non-rivalrous in consumption (consumers cannot be excluded from consuming the good, and consumption by one person does not affect the amount of the good available for others to consume)
Define a quasi-public good
A good that has some of the qualities of a public good but does not fully possess the two required characteristics of non-rivalry and non-excludability
Define the free-rider problem
When an individual cannot be excluded from consuming a good, and thus has no incentive to pay for its provision
Define asymmetric information
A situation in which some participants in a market have better information about market conditions than others
Define adverse selection
A situation in which a person at risk is more likely to take out insurance
Define moral hazard
A situation in which a person who has taken out insurance is prone to taking more risk
Define merit good
Goods with a positive externality in consumption
Give an example of external cost
e.g pollution when petrol is consumed when driving a car
Are goods with negative externalities over or under produced and consumed?
Overproduced and over consumed
Are goods with positive externalities over or under produced and consumed?
Underproduced and underconsumed
What are the 3 types of market failure?
Externalities
public goods
Information gaps
How do free markets work (4 ways)
Invisible hand
No government intervention
Price mechanism
Supply and demand mechanism
How is social cost calculated?
Private cost + external cost
Who is affected by an external cost?
A 3rd party
What happens to social costs in a free market system?
They are ignored
What are the 3 types of market failure?
Externalities
Public goods
Information gaps
What happens to public goods in a free market, and what is this called?
They go missing as people refuse to pay due to non-excludability, missing markets
Give an example of a quasi public good
National park
Define the tragedy of the commons
Public goods have no incentive to be looked after so the natural resources diminish
Name 2 reasons why govs should provide public goods
Loss of welfare due to ‘missing markets’ if unprovided
Only institution that can make payment compulsory
Name 2 reasons why govs shouldn’t provide public goods
Gov intervention may make things worse (government failure)
Opportunity cost - money may be better spent on other things
Define information gaps
When a party in a transaction doesn’t have full information
Why are information gaps bad?
Lead to purchase/sales errors as irrational decisions are made that are inoptimal - this is market failure as there is a misallocation of resources
