1.3 Market Failure Flashcards
(21 cards)
What is market failure?
Market failure occurs when the free market fails to allocate resources to the best interests of society, leading to an inefficient allocation of scarce resources.
Economic and social welfare is not maximised where there is market failure.
What are the types of market failure? (3)
Types of market failure include:
* Externalities
* The under-provision of public goods
* Information gaps
Define externality.
An externality is the cost or benefit a third party receives from an economic transaction outside of the market mechanism.
What are positive and negative externalities?
Externalities can be:
* Positive (external benefits)
* Negative (external costs)
What are private costs?
Private costs are the costs to economic agents involved directly in an economic transaction.
What are social costs?
Social costs are calculated by private costs plus external costs, representing the cost to society as a whole.
What is the difference between marginal social costs (MSC) and marginal private costs (MPC)?
External costs are shown by the vertical distance between MSC and MPC, indicating that MSC > MPC at free market equilibrium.
What are private benefits?
Private benefits are the benefits consumers derive from the consumption of a good, determined by the price they are willing to pay.
What are social benefits?
Social benefits are private benefits plus external benefits.
What is the social optimum position?
The social optimum position occurs where MSC = MSB, representing the point of maximum welfare.
What are external costs of production?
External costs occur when a good is produced or consumed, such as pollution, creating a gap between MSC and MPC.
What leads to over-provision and under-pricing in the market?
Market equilibrium ignores negative externalities, only reflecting producer costs (MPC). Societal cost (MSC) is higher, causing overproduction and under-pricing, thus market failure.
What is an example of an external benefit of consumption?
An example is the decline of diseases and healthier lives through vaccination programmes.
What are government policies to address negative externalities? (6)
Government policies include:
*Indirect taxes
*Regulation
*Provision of information
*Property rights
*Tradable permits
*Personal carbon allowances
What are public goods?
Public goods are non-excludable and non-rival, benefiting society but often underprovided in a free market.
What is the free-rider problem?
The free-rider problem occurs when individuals benefit from a good without paying for it, leading to underprovision.
What are quasi-public goods?
Quasi-public goods are partially provided by the free market, having characteristics of both public and private goods.
Footnote ##
Example: TV
Define symmetric information.
Symmetric information means that consumers and producers have perfect market information for decision-making.
What is asymmetric information?
Asymmetric information occurs when there is unequal knowledge between consumers and producers, leading to market failure.
What is the principal-agent problem?
The principal-agent problem arises when an agent makes decisions for a principal while acting in their own interests.
What is moral hazard?
Moral hazard occurs when a party with superior knowledge alters their behavior to benefit themselves at the expense of the other party.
