1.6: Market failure and externalities Flashcards
What are the assumptions of consumer behaviour?
- Agents choose independently
- Have fixed and stable preferences
- Agents gather complete information
- Always make the optimum choice
Why may individuals not act in a rational way?
- Difficult to calculate
- Hard to calculate utility beforehand
- Emotion
- Utility discovered after consumed
- Brand loyalties
- Social influences
- Defaults
- Altruism vs pure self interest - acts reciprocally instead of pure self interest
- Lack self control seeks immediate satisfaction
- Rather not lose than gain
- Habitual behaviour
- Social norms
- Mental preferences
- Herd behaviour
Why may people pay for a subscription but not use it?
- Inertia - lazy to face decision to cancel or do nothing
- Opportunity cost of time required to calculate utility so rather do nothing
- Hard to calculate value as never know when may need it
- Information gaps - don’t know if need it in future
Why may consumers give to charity?
- Herd effect and peer pressure
- Non monetary benefits
Why may people fail to save for retirement
Information gaps - don’t know benefits or value of money in future or how much they need
-Difficult to transfer money from present to future
What is market failure?
When the competitive outcome of markets is not efficient as the price mechanism has failed to produce a socially efficient outcome.
- The resource allocation is sub optimal, producing less social welfare possible than with the available resources
- Market doesn’t efficient allocate resources
- Markets are pareto efficient as often impossible to make one better off without making another worse off
What are merit and demerit goods?
Merit goods are under consumed when there is a lack of information on their benefits such as education, healthcare and pensions
Demerit goods are overconsumed as there is a lack of information about the negative effects of them such as drugs, fast food, alcohol and gambling
What is an externality? What are the 2 types?
Externalities are the spill over effects from production for which no compensation is paid to the third parties affected - neither the buyer nor seller. They are ignored by the price mechanism and so cause market failure if the mechanism does not account for the full social costs.
What are private, external and social costs?
Social cost = private cost + external cost
When negative production externalities exist social costs exceed private costs, creating the graph.
Why may the MSC not always be parallel?
If the MSC rises with more production it may pivot upwards as there is more social cost with more production.
What is the triangle of welfare loss?
A good with negative externalities gives off a marginal external cost indicated by the area between the MSC and MPC, which can then be demonstrated by the area of the triangle of welfare loss
What is social efficient output?
At this output there will be less output and higher prices, reducing the production and thus the external cost of production of the good
What are positive externalities?
There may be benefits from consumption of goods, giving higher social benefit when consuming at the social cost
Social benefit = private benefit plus external benefit
where positive externalities exist the social benefit therefore exceeds the private benefit
How are positive externalities graphed and what is the equilibrium and triangle of external benefit?
MSB>MPB, area between the two is external benefit
At the social efficient level Q2 will be higher and there will be a higher price to consider the external benefits.
What is done to reduce the impact of an externality?
The government internalise the externality by implementing a tax, normally indirect, to reduce the supply and demand on these goods and increase the price to meet the MSC, creating a new MPC
This brings it to the social efficient output where technically all costs are paid off or reduced, as there is less output
