Week 9 - market failure and government intervention

Question 1

Why do governments intervene in the market?

Answer 1

1. Mitigate externalities
2. Provide public goods
3. Correct Asymmetrical information
4. Create equitable distribution of income

Question 2

What types of regulation can a government impose to reinforce the price mechanism and stop abuse of market power?

Answer 2

1. Market conduct
2. Market structure
3. Market performance

Question 3

What is market conduct regulation?

Answer 3

It is regulating the conduct of a firm in a market place to improve competition.
It forbids rent-seeking
The types of behaviour the regulators are looking for are:
1. Predatory pricing (decrease prices to limit new competition).
2. Below cost selling (decrease prices below cost price to limit new competition).
3. Price discrimination (?)

Question 4

What is rent-seeking?

Answer 4

An activity designed to improve the welfare of one group at the expense of another group.

Question 5

What is market structure regulation?

Answer 5

It examines the degree of concentration in an industry. (concentration ratios are defined in terms of the market share of the top few companies).
Regulation can restrict mergers to avoid dominance in the market (avoid monopoly or oligopoly)

Question 6

What is market performance regulation?

Answer 6

It restricts the rate of return on capital to allow what is seen as fair profit.
However it can lead to over-capitalisation (increasing costs/debt higher than company value)
Or padding costs (artificially decreasing the revenue)

Question 7

What is asymmetrical information?

Answer 7

It is a market situation in which one party has more information than the other. The party with more information exploits their position.

Question 8

What forms can consumer law take?

Answer 8

1. Setting standards = where experts know what is best and consumers must be protected.
2. Improving information = consumers are still in control, they know their own best interests.

Question 9

What is the capture theory?

Answer 9

1. Government identifies a suitable area for regularion.
2. A regulatory agency is set up
3. Some regulators over time move to the firms being regulated. Industries have alot of influence over regulation.
4. “tar baby effect” = one regulation leads to another.

Question 10

What is meant by income distribution?

Answer 10

All modern governments redistribute income to a greater or lesser extent (i.e. taxes)
However there is a trade off:
1. Equal distribution of income (to maintain social cohesion)
2. Incentive structure (that will reward entrepreneurial behaviour).

Question 11

What is the Lorenz Curve?

Answer 11

It measures the inequality in a country.
It plots the cumulative proportion of income against the cumulative proportion of the population.
The closer to the line of equality (a 45 degree line) the more equally distributed is the wealth.

Question 12

What is Gini Coefficent?

Answer 12

The quantity related to the Lorenz curve
The shaded area between the curve and the 45* line.
If G is closer to 0 than the distribution is more equal
If G is closer to 1 than the distribution is not equal

Question 13

What is meant by the term externality?

Answer 13

It is the benefit of cost that effects someone who is not already included in the production or consumption (i.e. someone outside of the market)

Question 14

What actions can be taken to correct negative externalities

Answer 14

1. Nothing
2. Prohibit activity
3. Tax

Question 15

What is the Coase Theorem?

Answer 15

If transaction costs are low, market system can deliver an efficient outcome, even for externalities.

However:

1. Property rights have to be assigned
2. All parties have full information
3. All parties willing to except reasonable agreement.

Question 16

What is defined as a public good?

Answer 16

It must be:

1. Non-rival = you can consume it and it is still there for others to use.
2. Non-excludable = no one can be stopped from using it.