Flashcards in 1.4 Market Failure Deck (72):
What is market failure?
Exists when the price mechanism allocates scarce resources in an inefficient way ie. either an over or under allocation of goods and services.
What are some examples of market failure?
Underprovision of merit goods such as education and healthcare as these services would only be provided to those who were willing and are able to pay.
Under provision of public goods such as street lighting and public roads because producers cannot exclude those who do not pay from benefitting front he provision of the service.
Over provision of demerit goods such as tobacco and alcohol as there is a lack go government intervention in such markets.
Abuse of monopoly power charging customer prices above market equilibrium and hence associated inefficiencies.
When does market failure occur?
When the price machine cannot allocates resources efficiently but causes external costs or external benefits of production or consumption.
What a private benefits?
Benefits of production and consumption enjoyed by a third party.
What are private costs?
Costs of production and consumption that are the actual costs incurred by a third party.
What are social benefits?
The full benefits of consumption or production ie. the sum of private and external benefits.
What are social costs?
The full costs of consumption and production ie. the sum of private and externals costs.
What are externalities?
The external costs or benefits of an economic transaction causing the market to fail to achieve the social optimum level of output where marginal social benefits equal marginal social costs MSB=MSC.
What is the marginal private benefit?
The addition value enjoyed by third parties from the consumption or production of an extra unit of a particular good or service.
What is the marginal private cost?
The additional costs of production for firms or the extra charge paid by customers for the output or consumption for an extra unit of good or service.
What are external costs/negative externalities?
Costs incurred by a third party in an economic transaction for which no compensation is paid.
What are some examples of negative externalities?
Air pollution from factories
Noise pollution from nightclubs
Child obesity from junk food
Climate change from factories
What are external benefits/positive benefits?
Benefits enjoyed by a third party from an economic transaction.
What are some examples of positive externalities?
Law and order systems
Flood defence systems
What is the marginal social benefit?
The added benefit to society from the production or consumption of an extra unit of output ie. the sum of the MPC and marginal external costs.
What is the marginal social cost?
The extra costs of an economic transaction to society ie. the sum of the MPB and marginal external benefits.
What exerts positive externalities?
Production and consumption of public and merit goods.
What exerts negative externalities?
Production and consumption of demerit goods.
What are demerit goods?
Products that create negative externalities to a their party. Hence their production and consumption result in social costs being firewater than private costs of production and consumption MSC > MPC.
What are examples of demerit goods?
Cigarettes, alcohol and druygs.
Why do government intervene in the market?
To discourage the production and consumption of demerit goods.
What are the two ways governments try to result market failure?
Market based policies - intervention in the price mechanism to make the market forces of demand supply operate more effectively eg. taxation and tradable permits.
Government regulations - such as environmental standards.
How is taxation used to reduce the negative externalities?
Used to internalise negative externalities ie. the buyer and the seller pay for the true costs of their actions without any burden being placed on the third party.
What happens to the supply curve when the tax is implemented?
Shifts the supply curve to the left increasing the price and decreasing the quantity demanded.
What are the advantages of imposing a tax?
It increases the price and should therefore decrease the quantity demanded.
It creates tax revenue for the government which can be used on other goods and services.
What are the disadvantages of imposing a tax?
The demand for many of these products is price inelastic so the tax may have little impact on the level of consumption.
The tax on many of these products is regressive so has a greater impact on low income earners than on high income earners.
It can encourage smuggling and unofficial market activity.
What are tradable permits?
Pollution rights issued to firms thus capping the level of pollution from economic activity. The policy creates incentive not to pollute so that excess permits can be sold to other less efficient firms.
What happens when there is an increase in the demand for pollution permits?
It will raise the price of pollution rights but without affecting the level of output and hence the level of pollution. Hence an increase in the price of tradable permits also increase the opportunity cost to firms that pollute.
How else can government try to deal with negative externalities?
By imposing laws and regulations.
What are some examples of regulations?
Laws to regulate where people can drive.
Making it illegal for people to smoke, eat or use their phone while driving.
Motorcyclists being made to wear a he,emtn.
Laws on the minimum age people must be before legally purchasing alcohol or cigarets.
Laws restricting where people can smoke.
What are some advantages of imposing regulations?
Consumption of the good or service may be reduced.
Awareness of the negative impacts of demerit goods may change the behaviour of people in the long term.
Awareness of the positive impact of consumption of merit goods is raised.
What are some disadvantages of imposing regulations?
Restriction cause parallel markets to develop where the good or service can be purchased often at a very high price.
The government has no control over the quality of the good produced in parallel markets which in some cases can be dangerous.
People may still choose to break the rules.
The fine or punishment for ignoring the ban must be enforced and be set high enough to discourage consumption of the good or service.
What are merit goods?
Products that create positive externalities when they are produced or consumed. Hence the social benefits from the production and consumption of merit goods are greater than the private benefits.
What are some examples of merit goods?
Education, healthcare, trining.
Why are merit goods deemed of value to society?
Due to the positive externalities of production and consumption they improve the general standard of lining int he economy.
Why do positive externalities exist?
Because MSB > MPB of consumption at all level of output this is due to the existence of positive externalities of consumption hence there is market failure at the free market equilibrium as there is an underconsumption of the merit good.
Where is the socially optimum level of output for merit goods?
Where MSB = MSC.
Why is a welfare loss present?
Because of the underconsumption.
Why is government intervention needed?
So resource are more efficiently allocated with a greater level of output of merit goods.
Why may governments use a subsidy to increase consumption of merit gooods?
A subsidy is a sum of money given tot he producer to reduce the costs of production to eoncoruhae higher levels of output or to reduce the price of consumption for consumers.
How does the producer pass on some of the subsidy to the consumer?
In the form of lower prices, and keeps the remainder for themselves in the form of low production costs.
What are the limitations of using subsidies?
It is difficult to set a precise subsidy that ensures MPC = MSC and MPB = MSB.
The social return on the production and consumption of merit goods is difficult to measure.
If the PED for the good is inelastic the lower price has little impact on the quantity demanded.
There is always an opportunity cost in the provision of subsidies as the money could have been used on other government projects.
How can legislation be used to deal with positive externalities?
Laws are used to encourage greater consumption of goods and services with positive externalities such as compulsory education for children, the requirement for children to be vaccinated against certain diseases.
How can advertising be used to deal with positive externalities?
By influencing behaviour by informing and educating the public about the benefits of increased consumption of merit goods.
What are the advantages go advertising?
Behaviour and consumption of individuals and firms can change there is a rise in the consumption of merit goods and a fall in the demand for demerit goods.
Successful advertising may lead to culture changes in behaviour.
What are the disadvantages of advertising?
Not all advertising is effective.
It can take a long time to educate people and for the advertised message to be accepted and acted upon.
There is an opportunity cost of government expenditure on advertising ie. the money might have been spent on something else deemed to be more beneficial to society.
Why is direct provision of goods and services by the government a good thing?
Merit goods and public goods become accessible to everyone regardless of their income of social status.
What are the limitations of direct provision of goods and services by the government?
Economic inefficiency - healthcare services might encourage consumption beyond the socially optimum level if people do not have to pay for healthcare they are more likely to overuse it.
There is an opportunity cost of government provision as the money could have been spent on something else such as paying off government debt or possibly lowering tax rates.
In the case of a shortage of supply due to excess demand it can be difficult to decide who should be able to take advantage of the free government service.
What are public goods?
Goods and services that exert positive externalities with two key characteristics, non excludable and non rivalrous.
What does non rivalrous mean?
A persons consumption of a public good doesn't not limit the benefits available to other people.
What does non excludable mean?
Firms cannot exclude people form the benefits of consumption even if they do not pay.
What are examples of public goods?
National defence, emergency services and street lighting.
What are the characteristics of private goods?
Rivalrous, excludable and rejectable.
What is the free rider problem?
Where those who do not pay cannot be excluded from benefiting from the provision of public goods. Free riders are people who take advantage of the goods or services provided by the government but have not contributed to government revenue through taxation.
What is the issue with the free rider problem?
The market demand for a public good doesn't not actually exist. Its supply will be significantly below the socially optimum level if it exists at all.
How is the free rider problem eradicated?
Direct provision of public goods as these improve well being in the economy since the MSB > MPB of production and consumption. Most public goods would not be available if it were not for government provision.
What is the issue with direct government provision in this instance?
There is an opportunity cost involved in direct government provision. There is also potential government failure from intervening in markets as government do not necessarily know what is best for society.
What are common access resources?
Refer to communal or public property they are rivalrous in nature but are non excludable. As these resources are used by the general public they suffer from overuse and therefore lack of sustainability.
What are some negative externalities associated with common access resources?
Deforestation, pollution, overfishing and climate change.
Why are common access resources open to overuse?
Since there is no effective pricing mechanism so depletion and degradation of the resources occurs because consumers do not pay for them. This is inefficient and poses a threat to the sustainability of the source.
What is the tragedy of the commons?
The consequences of the abuse and inefficient use of common access resources where the users self interest leads to the destruction of these resources in the long run.
What does the tragedy of the common present problems for sustainability?
It becomes difficult to maintain or preserve the resources for future generations.
How is legislation used to increase sustainability?
Laws to protect fish and marine life, legislation to reduce CO2 emissions from vehicles.
How is a carbon tax used to increase sustainability?
A per unit tax on greenhouse has emissions. The purpose is to create incentives for firms and households to reduce pollution in order to reduce their tax liability. Carbon taxes are set by assessing the pollution costs and the associated administrative costs of controlling the pollution. Establishing the correct tac level is key to the effectiveness of carbon taxes in responding to market failure. If the tax is too low then firms will simony continue to pollute whereas if the tax is too high the escalated costs negatively affect profits, employment and consumers.
How is are cap and trade systems used to increase sustainability?
Government regulated emissions trading schemes using a market based approach. The regulator sets a limit on the total amount of emissions allowed in an industry and firms are issues emissions permits. Permits within a cap and trade system are feely traded allowing more efficient firms to sell their excess permits. This also creates an incentive for firms to develop clean technologies. Whilst cap and trade systems help to reduce carbon emissions they can also raise a significant amount of revenue for the government. It can be argues that the system is anti competitive and they can cause job losses due to higher costs of production.
How is funding for clean technologies used to increase sustainability?
Provided by governments to create incentives for firms to adopt a sustainable approach. It includes subsidies for the adoption of renewable energy sources and investment funding to reduce emission from deforestation and negative impacts of forest degradation.
What are the policies to reduce the threat to sustainability limited by?
The global lack of ownership of common access resources, the escalating global demand for scarce resources due to higher levels of economic activity and globalisation and thinned for international cooperating to deal with global issues threatening sustainability.
What is asymmetric information?
Exists when one economic agent in an economic transaction has more information than the other in a certain market. the existence of asymmetric information between buyers and sellers in a market results in market failure and inefficiencies, consumer and producer surpluses are not maximised.
How do governments deal with asymmetric information?
Legislation, regulation, provision of information.
When does abuse of monopoly power occur?
Lack of competition means that profit maximising monopolists are likely to supply less than the social optimum and charge higher prices so there is productive and allocative inefficiency. This results in a welfare loss for society so the abuse of monopoly such as their ability to exploit consumer surplus by using price discrimination is a type of market failure.
What are some examples of abuse of monopoly power?
Monopolists charging excessively high prices, collision (the agreement between firms with market power to set higher prices) and predatory pricing (setting low prices perhaps below the costs of production to force rival firms out of the industry).