1.3 market failure Flashcards
(19 cards)
market failure
occurs when the free market equilibrium does not lead to a socially optimal allocation of resources
3 types of market failure
*externalities
*under-production of public goods
*information gaps
positive externality
external benefits to 3rd parties outside the transaction (eg: education benefits companies hiring)
negative externality
external costs to 3rd parties outside the transaction (eg: pollution damages health)
private cost/benefit
the cost/benefit by a firm or consumer as part as of their production or economic activity
external cost/benefit
the cost/ benefit that 3rd parties receive (same concept as positive/negative externalities)
social cost/benefit
the sum of the private costs/benefits and external costs/benefits
welfare loss
a cost to society created by market inefficiency (triangle)
merit goods
goods that have greater social benefits than private benefits
demerit goods
goods that have greater social costs than private costs
public goods
non-excludable and non-rival goods (the inability to exclude consumers or used up the good) provided by the government such as street lighting which is beneficial to society but will not be provided by private firms
private good
excludable and rival goods which firms are able to provide to generate profits from
free rider problem
if firms provided public goods customers could access the goods without paying for them enjoying the benefits as they are ‘free-riding’ of other paying customers but over time customers who are paying for the goods will stop and firms will stop providing these goods and they will become under-provided in society
information gaps
when the buyer or seller does not have access to the information needed to make a fully informed decision
asymmetric information
when buyers and sellers have different levels of information (eg: sellers know more about the vehicle than the buyers when selling a second hand car)
symmetric information
when buyers and sellers have exactly the same level of information
moral hazard
when the buyer has more information than the seller (eg: someone that has car insurance may take more risks as any damages will be paid for)
adverse selection
when the seller has more information than the buyer (eg: car dealer will know how used a second hand car is when selling to a customer)
how can asymmetric information contribute to market failure
*causes market failure as buyers and sellers can make wrong decisions that result in inefficient allocation of resources
*asymmetric information distorts socially optimal prices and quantities in markets which results in over-provision or under-provision of goods/services
