Unit 8: Market Mechanism, Market Failure And Government Intervention In Markets Flashcards
When does market failure occur?
. When the free market interaction of demand and supply does not bring about the efficiencies or equity that society desires.
. When allocative inefficiency, productive inefficiency or inequity exists.
Consumer surplus formula:
Amount consumer is willing to pay- actual price.
8 things that cause market failure:
Public goods, externalities, demerit goods, merit goods, unacceptable income distribution, monopoly, factor immobility, unacceptable or inequitable income distribution or wealth.
How do you label and draw a negative/positive production externality diagram?
. X- axis: Quantity.
. Y- axis: Cost/Benefits.
. One negative gradient line labeled ‘Marginal Social Benefit=Marginal private benefit’.
. 2 positive gradient lines labeled ‘Marginal Social Cost’ and ‘Marginal private cost’.
. X axis labeled ‘Free Market Quantity’ under private cost equilibrium (with line linking both).
. X axis labeled ‘Allocative efficient quantity’ under social cost equilibrium (with line linking both).
. ‘Marginal private cost’ line is to the right of ‘marginal social cost’ line.
. Vertical arrow line labelled ‘-ve production externality’ between both +ve g lines.
What is the difference between a positive and negative production externality diagram?
. Positive: Marginal social cost line is to right of marginal private cost line. Vertical line with arrows between both lines labeled ‘Marginal External Benefit’.
. Negative: Marginal private cost line is to right of marginal social cost line. Vertical line with arrows between both lines labeled ‘Negative production externality’.
How do you label and draw a negative/positive consumption externality diagram?
. X- axis: Quantity.
. Y- axis: Cost/Benefits.
. One positive gradient line labeled ‘Marginal Social cost=Marginal private cost’.
. 2 negative gradient lines labeled ‘Marginal Social benefit’ and ‘Marginal private benefit’.
. X axis labeled ‘Free Market Quantity’ under private benefit equilibrium (with line linking both).
. X axis labeled ‘Allocative efficient quantity’ under social benefit equilibrium (with line linking both).
What is the difference between a positive and negative consumption externality diagram?
. Positive: Marginal social benefit line is to right of marginal private benefit line. Vertical line with arrows between both lines labeled ‘Marginal External Benefit’.
. Negative: Marginal private benefit line is to right of marginal social benefit line. Vertical line with arrows between both lines labeled ‘Marginal external cost (Negative consumption externality)’
How do you label and draw a carbon tax diagram?
. X-axis: Quantity.
. Y-axis: price.
. One demand curve with negative gradient labeled ‘D’.
. Two supply curves with positive gradients labeled ‘S’ and S1’ with an upwards arrow showing the shift to the left.
. X axis labeled ‘Q’ under S equilibrium (with line linking both).
. X axis labeled ‘Q1’ under S1 equilibrium (with line linking both).
. Y axis labeled ‘P’ to left of S equilibrium (with line linking both).
. Y axis labeled ‘P1 to left of S1 equilibrium (with line linking both).
. S equilibrium labeled ‘A’.
. S1 equilibrium labeled ‘B’.
. Draw a rectangle vertically connecting ‘B’ and ‘S’ (directly under it) and horizontally connecting with y-axis.
. Label height of rectangle ‘x’ (with arrow line). X is the amount of carbon tax.
How do you label and draw a cap and trade diagram?
. X-axis: Quantity.
. Y-axis: price.
. One demand curve with negative gradient labeled ‘D’.
. Supply curve with positive gradient labeled ‘S’.
. Vertical supply line labeled ‘S1’ with a diagonal arrow showing the shift to the left.
. X axis labeled ‘Q’ under S equilibrium (with line linking both).
. X axis labeled ‘Q1’ under S1 equilibrium (with line linking both).
. Y axis labeled ‘P’ to left of S equilibrium (with line linking both).
. Y axis labeled ‘P1 to left of S1 equilibrium (with line linking both).
. S equilibrium labeled ‘A’.
. S1 equilibrium labeled ‘B’.
. Draw a rectangle vertically connecting ‘B’ and ‘S’ (directly under it) and horizontally connecting with y-axis.
. Label height of rectangle ‘x’ (with arrow line). X is the amount of carbon tax.
How do you label and draw a diagram, showing the impact of tax and tax revenue?
. X-axis: Quantity (m)
. Y-axis: price (£).
. One demand curve with negative gradient labeled ‘D’.
. Two supply curves with positive gradients labeled ‘S’ and S1’ with an upwards arrow showing the shift to the left.
. S1 equilibrium labeled ‘F’.
. Point that’s directly left to F on Y axis labeled ‘E’.
. Point that’s directly under F on ‘S’ curve labeled ‘G’.
. Point that’s directly left to G on Y axis labeled ‘H’.
. Draw a rectangle with vertices EFGH.
. Label rectangle as ‘Vertical distance= value of tax per unit’.
. Say that ‘Total tax revenue = EFGH (Tax per unit X units sold)’
How do you draw and label a diagram, showing the imposition of a subsidy?
. X-axis: Quantity (m)
. Y-axis: price (£).
. One demand curve with negative gradient labeled ‘D’.
. Two supply curves with positive gradients labeled ‘S’ and S1’ with a downwards arrow showing the shift to the right.
. S equilibrium labeled ‘F’.
. S1 equilibrium labeled ‘Y’.
. Point that’s directly left to ‘Y’ on Y axis labeled ‘Z’.
. Point that’s directly above ‘Y’ on ‘S’ curve labelled ‘X’.
. Point that’s directly left to ‘X’ on Y axis labelled ‘W’.
. Draw a rectangle with vertices WXYZ.
. Label rectangle as ‘Vertical distance= value of subsidy per unit’.
. Say that ‘Total Subsidy payments= WXYZ’.
How do you label and draw a diagram, showing pollution permits for a negative production externality?
. Some of diagram is below and above x axis.
. X axis: Quantity.
. Y axis (above): MSC and MSB.
. Y axis (below): Pollution level.
. Above: positive g ‘MSC’ and ‘MPC’ line (MPC to right of MPC line with arrow between labelled -ve prod externality).
. Negative g ‘MSB=MPB’ line.
. MPC equilibrium called ‘Free market q’.
. MSC equilibrium called ‘allocatively efficient q’.
. Below: negative g ‘Pollution = f(q)’ line.
. Point that has same q as MSC equilibrium labeled ‘Ideal number of pollution permits’ on y-axis.
. Point that has same q as MPC equilibrium labeled ‘Free market pollution’ on y-axis.
What is government intervention?
. When the government acts in order to correct instances of market failure.
- Governments are assumed to intervene with the aim of maximising the social welfare of the entire nation and ensure justice and fairness.
What is the problem with government intervention?
. trade-offs of government intervention so helping one group may harm another and governments must decide between competing claims.
. Sometimes government action is totally ineffective, other times it doesn’t fully correct market failure and sometimes actions are counterproductive and make efficiency or equity. even worse.
What is government failure?
. Government failure occurs when state intervention worsens an existing market failure or creates a new market failure.
- occurs when state actions impose a cost greater than the benefits brought through the intervention.
- leads to greater misallocation of resources or further inequity.
List some causes of government failure:
Political self interest, The Law of Unintended Consequences, Costs of administration and enforcement, Policy decisions based on imperfect information, Conflicting Objectives, Regulatory capture, Incompetence and lack of incentives.
How can political self interest lead to government failure?
. The pursuit of self-interest amongst politicians and civil servants can often lead to a misallocation of resources or inequity.
- often government spending is not targeted at the most needy, this can be considered inequitable.
- The pressures of a looming election can cause inappropriate spending and tax decisions.
How can the law of unintended consequences lead to market failure?
Because actions of government have effects that are unanticipated or “unintended.”
- This may be because the consequences of policies have not been thought through or consumers/producers do not act in the way that the economics textbooks would predict.
How can costs of administration and enforcement lead to market failure?
Government intervention can prove costly to administer and enforce. The estimated social benefits of a particular policy might be largely swamped by the administrative costs of introducing it.
How can Policy decisions based on imperfect information lead to information failure?
It is difficult to know what the appropriate level of merit, demerit and public goods is and how to value externalities. Often a government chooses to go ahead with a project or policy without having the full amount of information required for a proper cost-benefit analysis.
