1.3 - market failure

Question 1

What is an externality?

Answer 1

Costs/benefits to 3rd parties who are not directly involved in a transaction between producers and consumers.

Question 2

How is the market failure created by negative externalities solved? (4 ways)

Answer 2

• Indirect tax
• Tradable pollution permits
• Minimum price
• Regulation

Question 3

How is the market failure created by positive externalities solved? (2 ways)

Answer 3

• Subsidies
• Maximum prices

Question 4

What is a public good?

Answer 4

A good that is non-rivalrous and non-excludable.

Question 5

What is the meaning of non-rivalrous and non-excludable?

Answer 5

Non-rivalrous: consumption by one person does not limit consumption by others.
Non-excludable: impossible to prevent anyone from using it.

Question 6

What is the free rider problem?

Answer 6

When a public good is provided, other people will be able to benefit from it without paying.

Question 7

How does the free rider problem lead to market failure?

Answer 7

An insufficient number of people will be willing to pay for the product and it will not be profitable for a business to provide it, so public goods would not be provided.

Question 8

How is the market failure created by non-provision of public goods solved?

Answer 8

State provision.

Question 9

What is asymmetric and symmetric information?

Answer 9

Asymmetric: one party in a transaction has more or superior information compared to another.
Symmetric: both parties in a transaction have the same information.

Question 10

Why would asymmetric information lead to market failure?

Answer 10

Resources will be allocated inefficiently.

Question 11

How is the market failure caused by information gaps solved? (3 ways)

Answer 11

• Provision of information via advertising
• Regulation
• Indirect tax/subsidy