Year 1 micro - market failure Flashcards

Question

how would an indirect tax solve market failure (negative production externality)

Answer 1

- increases firms cost of production, MPC shifts left to MSC = MPC + tax - price increases and quantity decreases(assuming the tax is perfect)

Answer 2

- we want the MPC = MPB - MPC curve shifts left to MPC + tax - price increases and quantity decreases

Answer 3

specific taxes introduced for a specific purpose, eg revenue used to advertise

Answer 4

2 billion per year

Answer 5

1.6 billion

Answer 6

When there is an under consumption or production of a good

Answer 7

FOR CONSUMPTION - MPB shifts right as cop reduces and will hit MPB at the socially optimum level FOR PRODUCTION - MPC will shift to the right to be equal to MSC , so MSC = MPC + sub - increase in quantity and reduction in price

Answer 8

1. Opportunity cost of government spending → The government must fund subsidies by diverting resources from other areas (e.g. healthcare or education) → This may reduce public investment in crucial sectors → Which can harm long-term growth and social welfare → Leading to inefficient allocation of public funds 2. Risk of dependency and inefficiency → Firms may become reliant on subsidies to remain profitable → This reduces their incentive to innovate or cut costs → Which can lead to productive inefficiency and X-inefficiency → Weakening international competitiveness in the long run 3. Government failure and poor targeting → Subsidies might be misallocated due to poor information or political motives → This results in resources going to less deserving or inefficient firms → Which distorts market signals and encourages rent-seeking behaviour → Ultimately causing government failure rather than solving market failure 4. Market distortion and reduced competition → Subsidies can give unfair advantages to certain firms or industries → Which may reduce incentives for new firms to enter the market → Leading to lower competition and potential monopolistic tendencies → Which worsens allocative and dynamic efficiency over time 5. Fiscal burden and sustainability issues → Funding subsidies adds pressure to government budgets → This may increase borrowing or require higher taxes in the future → Which can crowd out private investment or reduce disposable income → Undermining long-term macroeconomic stability

Answer 9

a rule of law enacted by the government that must be followed by economic agents to encourage a change in behaviour

Answer 10

it doesn’t work through a market (changing price then changing quantity)

Answer 11

- age limits - time limits - caps - compulsory regulation eg vaccines - bans

Answer 12

- needs to be enforcement of the regulation, or ppl won’t follow it - needs to be effective punishment to make sure there is an incentive to follow it

Answer 13

- incentive for firms and consumers to change behaviour , to move quantity to socially optimum level - solves issues in free market - to bring about allocative efficiency

Answer 14

1. Risk of Regulatory Capture When regulatory agencies oversee industries for a long time, firms may develop close relationships with policymakers, leading to regulatory capture. This means that instead of enforcing rules that protect consumers and society, regulators may start making decisions that benefit large corporations. If businesses successfully lobby for weaker regulations or exemptions, industries may become more concentrated, reducing competition. This allows firms to charge higher prices, reduce service quality, or exploit workers, ultimately harming consumers and the economy. 2. Stifling Innovation and Competition Regulations often impose strict rules on businesses, which can act as a barrier to entry for new firms. Startups and smaller firms may struggle to afford the legal compliance costs, while established firms with greater resources can absorb them more easily. This reduces competition in the market, leading to a concentration of power among a few dominant firms. As competition weakens, these firms face less pressure to innovate or improve efficiency, which slows technological progress and long-term economic growth. Over time, consumers experience fewer product choices and higher prices due to reduced market competition. 3. Risk of Unintended Consequences While regulation aims to correct market failures, it can sometimes create new inefficiencies. For example, strict environmental rules may require firms to invest heavily in cleaner technologies, which increases production costs. This can lead businesses to relocate to countries with weaker regulations, resulting in job losses and economic decline in the regulated economy. Similarly, price controls such as rent caps might seem beneficial to consumers, but they discourage property developers from building new homes. Over time, housing shortages emerge, worsening affordability issues and leading to unintended negative consequences.

Answer 15

Addresses market failure effectively - Regulations can correct market failures by imposing restrictions or standards that ensure optimal resource allocation. For instance, environmental regulations can reduce negative externalities like pollution by setting emissions caps or penalties. - This leads to improved societal welfare, as external costs are reduced, creating a cleaner environment and healthier communities. Provides consumer protection - Regulations ensure safety and fairness, such as product quality standards, food safety checks, or financial regulations that protect consumers from predatory practices. - This builds trust in markets and reduces exploitation, which encourages consumer participation and boosts economic activity. Encourages fair competition - Anti-monopoly regulations prevent firms from abusing market power through predatory pricing or collusion, maintaining a level playing field for smaller businesses. - This fosters innovation, diversity in product offerings, and competitive pricing, ultimately benefiting consumers. Increases Consumer Confidence and Product Safety Regulation ensures that products and services meet specific safety and quality standards, reducing the risk of market failures caused by information asymmetry. For example, food safety regulations, financial industry oversight, and consumer protection laws prevent harmful products from reaching the market. This increases trust in businesses, as consumers feel more confident purchasing goods and services without fear of fraud, dangerous defects, or misleading advertising. As a result, stronger consumer demand and stable markets promote long-term economic growth.

Answer 16

the excess of social benefit over social cost for a given quantity

Answer 17

1️⃣ Increased Production Costs → Lower Profit Margins Many firms rely on gas as a key input for manufacturing, transportation, and heating. As gas prices rise, the cost of production increases, leading to higher expenses for businesses. Firms may struggle to maintain profitability, especially if they cannot pass the costs onto consumers through price increases. This can result in lower profit margins, reducing firms’ ability to invest in expansion or research & development (R&D). 🔹 2️⃣ Higher Prices → Lower Consumer Demand → Revenue Decline If firms choose to pass higher gas costs onto consumers through higher prices, this can reduce demand for their goods/services. Many consumers have a limited budget, so they may cut back on non-essential spending when prices rise. Lower demand results in declining sales and revenue, especially in price-sensitive markets (e.g., retail, food production). If demand drops significantly, firms may be forced to cut costs elsewhere, such as reducing wages or employment. 🔹 3️⃣ Supply Chain Disruptions → Reduced Productivity Higher gas prices increase transport and logistics costs, affecting firms that rely on shipping, distribution, and supply chains. Rising fuel costs can lead to higher freight and delivery costs, making imported goods more expensive and supply chains less efficient. Some suppliers may raise their own prices, further increasing input costs for firms dependent on raw materials and components. This can lead to delays in production, higher inventory costs, and lower overall productivity. 🔹 4️⃣ Inflationary Pressures → Increased Wage Demands → Wage-Cost Spiral Rising gas prices contribute to higher inflation, increasing the overall cost of living for workers. Employees may demand higher wages to compensate for rising expenses, increasing firms’ labor costs. If firms agree to wage increases, this raises their total costs, potentially leading to further price hikes for consumers. This can create a wage-cost spiral, where rising wages and prices continuously feed into each other, worsening inflation. 🔹 5️⃣ Risk of Business Closures → Unemployment and Market Uncertainty Smaller firms, particularly those with low profit margins, may be unable to absorb the higher costs of rising gas prices. If firms cannot sustain operations, they may be forced to cut jobs or shut down entirely, leading to higher unemployment. Widespread business closures can have negative spillover effects on the economy, reducing economic confidence and investment levels. This can also lead to a decline in market competition, allowing larger firms to gain market power and potentially raise prices further. increased demand for cleaner energy : as they make fossil fuel alternatives more expensive and renewable energy sources become more competitive When gas prices rise, the cost of electricity from fossil fuels increases, making renewable energy sources like solar and wind more attractive and competitive Higher gas prices can lead to increased demand for renewable energy, as consumers and businesses seek cheaper alternatives to power their operations

Answer 18

1️⃣ Higher Revenues for Energy Companies → Increased Investment Firms in the oil and gas industry (e.g., gas producers, refiners, and energy suppliers) benefit directly from higher prices. As gas prices increase, these firms experience higher revenue and profit margins, allowing for greater investment in exploration, production, and infrastructure. Increased investment can lead to technological advancements and efficiency improvements, benefiting the industry in the long run. Higher profits can also increase shareholder returns, boosting investor confidence in the sector. 🔹 2️⃣ Incentive for Energy Efficiency → Lower Long-Term Costs Rising gas prices encourage firms to adopt energy-efficient technologies, reducing their dependency on fossil fuels. Firms may invest in renewable energy sources, such as solar, wind, or geothermal, leading to long-term cost savings. Improved energy efficiency can also lower operating costs in the future, making firms more competitive and less vulnerable to energy price volatility. Over time, this can enhance sustainability, reduce carbon emissions, and align businesses with environmental goals and regulations. 🔹 3️⃣ Growth Opportunities for Alternative Energy and Green Tech Firms High gas prices increase the demand for alternatives, benefiting firms in the renewable energy, electric vehicle (EV), and battery storage industries. Companies producing solar panels, wind turbines, hydrogen fuel cells, or EV charging infrastructure experience increased investment and sales. As demand shifts towards greener energy solutions, firms in these industries can expand, creating new market opportunities. Governments may introduce subsidies and incentives to accelerate this transition, further benefiting firms in the clean energy sector. 🔹 4️⃣ Competitive Advantage for Firms with Energy-Efficient Supply Chains Firms that already operate with lower energy costs (e.g., those using energy-efficient production methods) gain a cost advantage over competitors. Businesses that have invested in sustainable practices experience less impact from rising gas prices, making them more attractive to cost-conscious consumers and investors. This can lead to greater market share, improved brand reputation, and stronger customer loyalty. Over time, competitors may be forced to follow suit, driving industry-wide improvements in efficiency and innovation. 🔹 5️⃣ Potential Increase in Demand for Domestic Goods and Services If gas prices increase significantly, it becomes more expensive to import goods due to higher transportation and freight costs. This can create an opportunity for domestic producers, as firms and consumers may substitute imports with locally produced alternatives. Increased demand for domestic goods can stimulate local industries, create jobs, and boost economic activity in certain sectors. Governments may also implement policies supporting domestic industries, such as tax incentives or subsidies, to reduce reliance on imports.

Answer 19

1️⃣ Impact Depends on the Industry Energy producers and renewable energy firms benefit, while energy-intensive industries (e.g., manufacturing, transportation, agriculture) suffer from higher costs. The overall effect on firms depends on their energy dependency and ability to pass on costs to consumers. If demand is inelastic, firms may successfully raise prices; if demand is elastic, firms may lose customers, reducing revenues. 🔹 2️⃣ Short-Run vs Long-Run Effects Short run: Higher gas prices cause an immediate cost shock, increasing production costs and inflationary pressures. Long run: Firms may adapt by investing in energy efficiency and renewables, reducing dependence on fossil fuels. If high gas prices persist, firms that fail to innovate may lose competitiveness, while others may gain a strategic advantage. 🔹 3️⃣ Role of Government Policy and Regulation Governments may intervene through price caps, fuel subsidies, or tax breaks to help businesses cope with rising costs. Increased gas prices could lead to greater incentives for green energy investment if governments provide subsidies for renewables. However, excessive intervention (e.g., subsidies for fossil fuels) may delay the transition to sustainable alternatives. 🔹 4️⃣ Global Economic Conditions and Supply Chains If gas prices rise due to global factors (e.g., conflicts, supply chain disruptions), firms may have little control over their exposure to these costs. Countries that rely on gas imports will experience higher inflation and trade deficits, worsening economic conditions. If alternative energy sources are not widely available, firms may struggle to reduce costs quickly, leading to lower investment and slower growth. 🔹 5️⃣ Consumer and Business Confidence High energy prices may lead to lower disposable income, reducing consumer demand for goods and services. If firms expect gas prices to remain high, they may delay investment and hiring, slowing down economic growth. However, if firms see an opportunity (e.g., shifting to renewables), investment may increase in sectors that benefit from the transition.