1.3 - types of market failure Flashcards
(33 cards)
What is market failure?
When markets don’t produce/consume the socially optimal level of output or when the price mechanism leads to an inefficient allocation of scarce resources. This leads to a loss in social welfare.
What type of externality is there due to under-consumption?
Positive externality. PMB < SMB.
What type of externality comes from over-production?
Negative externality. PMC > SMC.
What is the social optimal?
Where SMC = SMB.
What calculation involves the social benefit (SB)?
SB = PB + Positive externality/external benefits.
What calculation involves the private cost (SC)?
SC = PC + Negative externality/external costs.
Where is the private equilibrium found?
PMC = SMB or PMB = SMC
What is the marginal private benefit (MPB)?
The benefit to the individual of consuming the last unit of a good
What is the marginal private cost (MPC)?
The cost to a firm of producing the last unit of a good
What is the Marginal social benefit (MSB)?
The benefit to the individual consuming the good plus the external benefit of the last unit of the good.
What is the marginal social cost (MSC)?
The cost to the firm plus the external cost of producing the last unit of a good.
What are externalities?
Third-party spill over effects (costs or benefits) resulting from production and consumption for which no compensation is paid or received.
Where can the deadweight loss be found on a diagram?
The area of the triangle
Where can the externality be found?
The height of the triangle.
What is a private good?
A good which is excludable and rivalrous in consumption.
What does rivalrous mean?
They can only be used by one person at a time. They generally cost money and this ensures the exclusive use to the purchaser.
What does excludable mean?
They are not freely available as not everyone can afford to pay the price for the good.
What are public goods?
A good which is non-excludable and non-rivalrous. Consumption can’t be confined to those who have paid for it eg. streetlights
What is the free rider problem?
Occurs when consumers are enjoying the benefit without incurring a cost. This distorts market incentives because if consumers have no incentive to pay, then suppliers have no incentive to produce.
How are public goods supplied?
They are supplied by the government via the collective payment of general taxation. Private sector firms will not provide public goods as they can’t be sure of making a profit, so the market may fail.
What are information gaps and how do they lead to market failure?
Consumers aren’t always aware of the quality and advertising may distort the benefits of goods and services. Also, firms have incomplete information about prices, costs, labour productivity and behaviour of rivals. Firms can take advantage of consumers by making false claims. Economic agents do not always make rational decisions so resources are misallocated as people don’t maximise their welfare.
What is consumer protection?
Makes it illegal for firms to sell dangerous goods or mislead consumers via inaccurate advertising.
What is moral hazard?
A situation where an economic agent has an incentive to increase exposure to risk because they don’t bear the full costs of the risk. eg, if they have insurance for a good.
What is the principal-agent problem?
One party (an agent) acts on behalf of a principal. If the agent has more information about the actions, they may have an incentive to act too riskily, if the interests are not aligned. The goals of the principal may be different from the goals of the agent.
