Why Do Markets Fail Flashcards
Externalities
Costs or benefits which are external to an exchange
They are third party effects ignored by price mechanism
Market failure
Occurs when price mechanism causes an inefficient allocation of resources , the forces of demand and supply lead to a net welfare loss in society , consequently resources are not allocated to their best optimum use
External costs
Occur in the production / consumption of good / service
Production- e.g. Chemical firm polluting river
Consumption- e.g. Person smoking tobacco , polluting air for others
Private costs
Cents internal to the firm which it directly pays for e.g. Wages, rent of buildings, raw materials, machinery costs
Social costs
By adding private costs to external costs we obtain social costs
External benefits
Occur in the production/ consumption of a good/ service
Positive third party effects and represent benefits lout side market transaction
E.g. Recycling of waste materials such as glass- has benefit of reducing amount of waste disposal for landfill sites as well as re using materials for production
Helps to promote sustainable economic growth
E.g. Vaccination of individual against various diseases - reduces possibility of other people catching a disease who come into contact with vaccinated individual
Private benefits
Can be measu rede by price that consumers are prepared to pay for good/ service
Also refer to revenue that from obtains from selling good/ service
Free market equilibrium
Occurs when marginal private benefit equals marginal private cost
Social optimum equilibrium
Level of output/ price for a good occurs where marginal social cost equals marginal social benefit
Welfare is maximised
Public goods
Nt produced through markets
Involve large element of collective consumption e.g. National defence, criminal justice system
Non - excludability : once good produced for benefit of one person it is impossible to stop others from benefiting as well
Non-rivalry: as more people, consume a good and enjoy its benefits to does not reduce amount available for others
Private goods
Display characteristics of rivalry and excludability
Why are public goods under provided? (2)
1) FRE RIDER PROBLEM : market fails because it is impossible for firms to withhold the good from those consumers who refuse to pay
2) VALUATION PROBLEM: difficult to measure value obtained by consumers of public goods and hence it becomes hard to establish a market price for them, it is in the interest of consumers to undervalue the benefit gained from a public good so that they pay less for it but it is on the interest of the producer to over value the benefit gained to charge more
Gov provision of public goods
In mixed economy gov tends to provide public goods in order to correct market failure
It raises fund from taxation
Without gov intervention public goods may be under provided or not provided at all
Actual quantity provided will be less than the amount required for achieving the social optimum position
Symmetric info
Where consumers and producers have perfect and equal market information on a good / service
Assuming that consumers & producers act in a rational way it will lead to efficient allocation of resources
Asymmetric info
Consumers and producers have imperfect and unequal market knowledge upon which to make their economic decisions and this could lead to the misallocation of resources
E.g. A second hand car sales man knows more about the car than the potential buyer; this could lead to a consumer paying too much for a poor quality car ; the fear of buying a defective car tends to reduce market price for all second hand cars ; consequently the losers could be both buyers and sellers = LEMON MARKET
Markets are this likely to fail , can be seen in underconsumption of healthcare, education, pensions ( merit goods) and over consumption of tobacco, alcohol & gambling ( demerit goods)
