1.3 market failure Flashcards
(45 cards)
what is the definition of market failure?
- occurs when the market fails to allocate scarce resources efficiently
- where the market mechanism doesn’t result in socially optimum quantity or price
name the types of market failure
information failure/gaps
externalities
underprovision of public goods
moral hazard
speculation/market bubbles
explain what externalites are
the third party (spillover) effects arising from the consumption and production of goods/services
explain what the underprovision of public goods is
the market may fail to provide certain goods/services or underprovide them due to the fact that it is relatively easy to gain the benefits from the goods without having to pay for it - free rider principle
explain what information failure/gaps are
imperfect information - the buyers and/or sellers do not have all the information necessary to make an informed decision
asymmetric information - where one party, either the buyer or the seller, has more information about the product’s quality or price than the other party
explain what moral hazard is
a term to describe a situation in which an individual or organisation is protected from the consequences of their actions
explain what speculation and market bubbles are
speculation - an economics agent buys or sells something in the expectation of a future price change in the hope of generating a profit
market bubble - a spike in asset values within a particular industry, commodity, or asset class to unsubstantiated levels, fueled by irrational speculative activity that is not supported by the fundamentals
what is an external benefit?
a benefit to a third party outside the transaction
what is an external cost?
a cost to a third part outside the transaction
what is a social benefit?
the total benefit to private individuals and third parties:
private benefit + external benefit
what is a social cost?
the total cost to private individuals and third parties:
private cost + external cost
what is a private cost?
costs to the producing firm of producing an additional unit of output
what is a private benefit
benefits to the consumer of consuming an additional unit of output
externalities are
the effects that producing or consuming goods have on other third parties or society as a whole
externalities may lead to market failure as
buyers or producers do not consider externalities when making decisions therefore goods or services can be under or over consumed
positive consumption externalities are
‘good’ externalities created in the consumption of a good
on a negative production externality diagram, how do you find socially optimum equilibrium?
where MB (MSB) meets MSC
on a negative production externality diagram, how do you find private equilibrium?
where MB (MSB) meets MPC
on a negative production externality diagram, how do you find under/over consumption in a private market?
overconsumption - the difference between the quantity at social equilibrium and at private equilibrium
on a positive consumption externality diagram, how do you find social equilibrium?
where MC (MSC) meets MSB
on a positive consumption externality diagram, how do you find private equilibrium?
where MC (MSC) meets MPB
on a positive consumption externality diagram, how do you find under/over consumption in a private market?
underconsumption, the difference between the quantity at social equilibrium and at private equilibrium
give ways the government can correct externalites
indirect taxes and subsidies
tradable pollution permits
provision of the good
provision of information
regulation
explain how indirect taxes and subsidies affect externalities
- taxes can be put on goods with negative externalities and subsidies on goods with positive externalities
- these help to internalise the externalities, moving production closer to the social optimum position
