1

Question 1

market failure

Answer 1

When the market mechanism fails to allocate scarce resources efficiently and society suffers as a result

Question 2

Complete market failure

Answer 2

When no market exists so the good is not provided at any price eg national defence

Question 3

Partial market failure

Answer 3

When the market functions, but either the price or quantity supplied of the good/service is wrong eg healthcare

Question 4

External cost caused by?

Answer 4

Externalities

Question 5

Social cost

Answer 5

The full cost borne to society of a good/service

Question 6

Merit good

Answer 6

A good whose consumption is regarded as beneficial to society.
They provide benefits to both and individuals due to the positive externalities that arise form their consumption, but people are unaware of the full benefit that merit goods provide.

Question 7

Name three reasons why merit goods are under consumed

Answer 7

1)positive externalities are ignored
2)imperfect/asymmetric information
3)bounded rationality/self control

Question 8

Imperfect information

Answer 8

Occurs when people do not have accurate or complete information about the full benefits/drawbacks of the good.

Question 9

Asymmetric information

Answer 9

When one economic agent knows more than the other eg Moral Hazard: people unafraid to take risks because they wont suffer the consequnces themselves

Question 10

Bounded rationality

Answer 10

When consumers do not consider the consequences due to limited cognitive resources or time pressures. Instead, they may rely on heuristics such as brand familiarity or rules of thumb which can lead to suboptimal decisions.

Question 11

Bounded self-control

Answer 11

Refers to the difficulty consumers face in resisting short-term temptations, even when they are aware of the long-term costs.

Question 12

Public good: Non excludability

Answer 12

When people cannot be stopped from consuming the good even if they haven’t paid for it eg national defence

Question 13

Public good: Non-rivalry

Answer 13

When one person benefitting from the good doesn’t stop others from also benefitting because public goods have zero marginal cost

Question 14

Quasi public goods

Answer 14

Exhibit the characteristics of public goods but not fully eg congestion charges mean roads are quasi-public

Question 15

Free rider problem

Answer 15

means that once a public good is provided it is impossible to stop someone from benefitting from it, even if they haven’t paid for it

Question 16

Tragedy of the Commons

Answer 16

the idea that people acting in their own best interests will overuse a common resource without considering that this will lead to the depletion or degradation of the resource.

Question 17

Indirect tax

Answer 17

A tax imposed on producers on goods and services eg excise duty or VAT

Question 18

Specific tax

Answer 18

there is a fixed amount charged per unit regardless of the price of the good

Question 19

Ad valorem tax

Answer 19

charged as a proportion of the price of a good.

Question 20

What are the advantages of taxation

Answer 20

1)internalises externality
2)generates tax revenue which can be hypothecated

Question 21

What are the disadvantages of taxation?

Answer 21

1)governments do not have perfect information to ensure the tax equals the cost of the externality ( if tax is too low will be ineffective, if tax is too high will encourage tax evasion and black markets)
2) ineffective if demand is inelastic
3)regressive
4)paternalistic

Question 22

What is important to show in a diagram for negative externalties

Answer 22

inelastic demand curve due to addictive tendency

Question 23

Subsidy

Answer 23

money given to firms by the government to help an industry by keeping prices low or increasing supply

Question 24

What are the advantages of a subsidy

Answer 24

1)externality is internalised
2) prices fall so greater affordability and consumer surplus increases
2)subsidy can support a domestic industry until it can exploit EOS
3)increase in producer revenue and surplus

Question 25

What are the disadvantages of a subsidy?

Answer 25

1)increased govt spending increases debt and can lead to a tax rise (regressive) and there is an opportunity cost 2)can lead to inefficient firms if firms give subsidy to shareholders or become reliant 3)can be a myopic policy if subsidy is not conditional so does not address root cause (unintended consequences)

Question 26

Minimum price

Answer 26

A legally imposed price floor, beneath which producers can’t sell. It is designed to increase consumption of a merit good or lower its price so it is more affordable.

Question 27

What are the advantages of minimum price?

Answer 27

1)producers guarantee minimum income and there is a rise in producer surplus 2)internalises externality

Question 28

What are the disadvantages of minimum price?

Answer 28

1)consumers pay higher prices so consumer surplus falls (regressive) 2)ineffective if demand is price inelastic (regressive) so poorer people may cut spending on basic needs + doesn't affect wealthy people 2)opportunity cost and cost of buying up supply is a misallocation of resources (distortional and doesn't solve root problem long term) 3) no tax revenue 4)govt doesn't have perfect information to decide on the right price for the ceiling

Question 29

What are the advantages of maximum price?

Answer 29

1)prevents monopoly exploitation 2)increases affordability

Question 30

What are the disadvantages of maximum price?

Answer 30

1)govt imperfect information of ideal max price can lead to emergence of black markets or be ineffective 2)disincentives production which can lead to supply side issues in the long run 3)regressive as some producers withdraw investment choosing not to supply the good and can lead to lower quality as profits are less likely to be reinvested 4) ineffective if supply is inelastic

Question 31

Tradable pollution permit

Answer 31

involve the government giving firms a legal right to pollute a certain amount, creating a market for pollution permits with the price set by demand and supply.

Question 32

What are the advantages of tradable pollution permits?

Answer 32

1)internalises externality 2)raises government revenue 3)provides long run incentive to invest in green tech

Question 33

What are the market mechanism arguments?

Answer 33

1)market mechanism is the best way reduce externality (incentives) 2)rewards efficiency as green firms are essentially subsidised and polluting firms are taxed 3)provides flexibility for firms to choose (less paternalistic)

Question 34

What are the disadvantages of tradable pollution permits?

Answer 34

1)administrative costs 2)difficult to find optimal output - if output is too low it can lead to firms shutting down or relocating, if output is too high it is ineffective 3)difficult to find optimal price for permit- if too low there will be no incentive to change behaviour and externality is not internalised (market failure) 4)Depends on... global cooperation

Question 35

Regulation

Answer 35

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

Question 36

What is the advantage of regulation?

Answer 36

The incentive to change behaviour results in an increase in allocative efficiency and welfare gain

Question 37

What are the disadvantages of regulation?

Answer 37

1)cost of enforcement 2)too harsh regulations can lead to black markets or firms leaving or higher prices for firms (too lax regulations means no incentive to change behaviour) 3)paternalistic- excessive bureaucracy 4)regulatory capture

Question 38

What are the issues with information provision?

Answer 38

1)cost 2)no guarantee of success (poorly targeted) 3)can take time to change behaviour

Question 39

Direct Provision

Answer 39

The government provides a good or service free at the point of consumption

Question 40

What are the advantages of direct provision

Answer 40

1)reduces inequality 2)public good-provides missing market 3)allocative efficiency and welfare max

Question 41

What are the disadvantages of direct provision?

Answer 41

1)rationing excess demand (long waiting lists/ballots) 2)opportunity cost 3)inefficiency of state organisations - no profit motive to satisfy consumers and x inefficiency