Y12 Booklet 3: Market Failure Flashcards
What is a luxury good?
When income rises, demand rises more than proportionately
What is a normal good?
When income rises, demand rises
What is an inferior good?
When income rises, demand falls
What is excludability?
When someone can be prevented from benefitting from a good, e.g. paying for cinema tickets
What is rivalry?
When consumption by one person impacts another person’s ability to gain utility from it, e.g. a box of chocolates
What is a private good?
Both excludable and rivalrous
What is a public good?
Both non-excludable and non-rivalrous
What is a non-rejectable good?
A good which can not be turned down, e.g. a lighthouse
What problem does non-excludability cause?
Free-rider Problem
What is the Free-rider Problem?
If a good is non-excludable, a price can’t be charged for it. Therefore, as utility-maximisers, everyone expects a free ride since they don’t have to pay. Therefore, there is no profit incentive for suppliers, so these goods aren’t produced
What is the marginal cost of non-rivalrous goods?
Zero
What does marginal cost mean?
The cost difference of producing 1 additional unit
What is a good which possesses some traits of a public good, but not all?
Quasi-public good / non-pure public good
When does allocative efficiency occur?
When Price = Marginal Cost
When does a market fail?
When there is misallocation of resources (failing to reach allocative efficiency)
What are the 3 functions of prices?
Signalling;
Incentive;
Rationing/Allocative
What is the signalling function of prices?
Shows scarcities/surpluses
Used by producers to increase/decrease supply to meet equilibrium
What is the incentive function of prices?
Shows changing wants and needs of consumers
Specific to free markets since decision-making is decentralised
What is the rationing/allocative function of prices?
Decides how scarce resources are allocated
Acts as a barrier so only the most willing/able consumers can purchase the good
What is the price mechanism?
How consumer/producer interactivity determines the price and therefore allocation of resources
Part of a successful economy, leads to equilibrium
Promotes consumer sovereignty
What is consumer sovereignty?
A consumer’s power to choose what/how much is produced by purchasing certain goods at certain prices
What is a missing market? (Complete Market Failure)
When incentive function of prices fails and there are no producers for a good
What is a partial market failure?
When a market does provide a good, but in an allocatively inefficient quantity
What are 3 reasons for market failure?
Merit & Demerit goods
Information Failure
Externalities
What is the Tragedy of the Commons?
When an individual acts in a way which maximises their own utility in the short-term at the cost of society in the long-term, depleting a resource (e.g. cows grazing on a village common)
Why doesn’t the Tragedy of Commons occur for public goods?
Because they are non-rivalrous, so additional/over-consumption doesn’t affect available utility of others, so the good can’t be depleted
What is a merit good?
When a good is more beneficial to a consumer than it is believed to be
What is a demerit good?
When a good is more harmful to a consumer than it is believed to be
How are merit goods consumed in free markets? Examples?
Underconsumed, e.g. education, healthy food, insurance
How are demerit goods consumed in free markets? Examples?
Overconsumed, e.g. cigarettes, fast food, alcohol
What type of statement is a merit/demerit good? Why?
Normative; requires a value judgement
What are Information Failures?
When an economic agent does not have/understand/act on information fully, and so fails to maximise their own utility in the long-term due to their own perceptions
What is a search good?
A good that a consumer has all the available information without trying the good e.g. petrol, clothes, stationary
What is an experience good?
A good that a consumer has to try out to get all the available information e.g. houses, food, cars (to a non-expert)
What is asymmetric information in a market?
When one of the 2 parties (buyer and seller) know more about the good than the other. This is an example of information failure
What is the graph for underconsumption of merit goods?
What is the graph for overconsumption of demerit goods?
