Week 5 - Market failure Flashcards
What is equity?
Is a normative judgement - different for different people
Types of equity
- Horizontal equity
- Vertical equity
Define horizontal equity
Identical treatment of identical people
Define vertical equity (2)
- The different treatment of different people in order to reduce the consequences of these innate differences
- E,g Income tax
Define Pareto efficiency
- For given tastes, inputs and technology an allocation is ‘efficient’ if no one can be better off without making someone else worse off
- Market equilibrium can be shown to be Pareto efficient
Interpret a Competition and Pareto-efficiency graph in equilibrium (4)
- D is the demand curve, but also the marginal product benefit curve (MPB)
- S is the supply curve, but also represents the marginal private cost curve (MPC)
- At point A, the consumers’ willingness to pay is equal to the firms’ willingness to supply
- MPB = MPC (Pareto efficient)
Interpret a Competition and Pareto-efficiency graph in disequilibrium
- At P, the willingness of consumers buy is greater than the willingness of producers to supply
- Thus there is potential Pareto improvement
- Point A is efficient and there is no government intervention
Ways market failure arises (4)
- Imperfect competition (P > MC)
- Taxation - creates distortions such that P > MC
- Externalities
- Missing markets
What is an externality? (2)
- An externality is a cost or benefit, not transmitted through prices, incurred by a third party who did not agree to the action causing the cost or benefit
- Externalities can also be as a result of consumption aswell as production
Example of positive externality
Spill-over expects created by foreign direct investment in a host country
Interpret a negative externality in production diagram (3)
- MPC = MPB
- MSC => externality
- Q > Q* = overproducing
Impact of pigovian tax when there is a negative externality (3)
- MPC => MPC
- Now at A:
- Price = P2
- Quantity = Q*
• MPC = MSC = MPB = MSB
Define public goods
Are goods not provided by the private market because of the free-rider problem
Examples of public goods are free riders
Street lighting - Charging people for using them would be very difficult as a result the firm would make no revenue and goes bust
Define public good
A good/service that is provided without profit to all members of a society either by the goverment or by a private firm
Two characteristics of public goods
- Non-rivalrous
- Non-excludable
Define non-rivalrous - characteristic of public good
One person consuming it doesn’t affect the ability of someone else to consume it (e,g national defence)
Define non-excludable (characteristic of public goods)
You cannot stop an individual from consuming the good e.g street lightning
Examples of public goods
- Flood defences
- Immunisation projects
- Policing etc
What is asymmetric information? (2)
- Is where one party has more information than another therefore is unlikely that a socially optimal equilibrium will be reached
- Social equilibrium is unlikely to be reached as party with more info may exploit the other party e.g buying something that’s second hand
What is adverse selection? (2)
- Refers to a market process in which “bad” results occur when buyers and sellers have asymmetric information
- Example would be life insurance where the most risky will charge a premium to make sure they are covered
Define moral hazard
Occurs when a party insulated how risk behaves differently than it would be have if it were fully exposed to the risk
Examples of moral hazard (2)
- Mobile phone insurance - Insure my phone therefore I’m less careful as it can be replaced
- Bond bail out - by bailing out the banks in the 07/08 financial crisis have we encouraged them to take more risks
