1.3 - types of market failure

Question 1

Why does market failure occur?

Answer 1

When markets don’t produce the social optimal level of output or there is an inefficient allocation of resources.

Question 2

What type of externality is there due to under-consumption?

Answer 2

Positive externality. PMB < SMB.

Question 3

What type of externality comes from over-production?

Answer 3

Negative externality. PMC > SMC.

Question 4

What is the social optimal?

Answer 4

Where SMC = SMB.

Question 5

What calculation involves the social benefit (SB)?

Answer 5

SB = PB + Positive externality/external benefits.

Question 6

What calculation involves the private benefit (SC)?

Answer 6

SC = PC + Negative externality/external costs.

Question 7

Where is the private equilibrium found?

Answer 7

PMC = SMB or PMB = SMC

Question 8

What is the marginal private benefit (MPB)?

Answer 8

The benefit to the individual of consuming the last unit of a good

Question 9

What is the marginal private cost (MPC)?

Answer 9

The cost to a firm of producing the last unit of a good

Question 10

What is the Marginal social benefit (MSB)?

Answer 10

The benefit to the individual consuming the good plus the external benefit of the last unit of the good.

Question 11

What is the marginal social cost (MSC)?

Answer 11

The cost to the firm plus the external cost of producing the last unit of a good.

Question 12

What are externalities?

Answer 12

Third-party spill over effects resulting from production and consumption for which no compensation is paid or received.

Question 13

Where can the deadweight loss be found on a diagram?

Answer 13

The area of the triangle

Question 14

Where can the externality be found?

Answer 14

The height of the triangle.

Question 15

What is a private good?

Answer 15

A good which is excludable and rivalrous in consumption.

Question 16

What does rivalrous mean?

Answer 16

They can only be used by one person at a time. They generally cost money and this ensures the exclusive use to the purchaser.

Question 17

What does excludable mean?

Answer 17

They are not freely available as not everyone can afford to pay the price for the good.

Question 18

What are public goods?

Answer 18

A good which is non-excludable and non-rivalrous. Consumption can’t be confined to those who have paid for it.

Question 19

What is the free rider problem?

Answer 19

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.

Question 20

How are public goods supplied?

Answer 20

They are supplied by the government via the collective payment of general taxation.

Question 21

What is asymmetric information/information gaps?

Answer 21

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.

Question 22

What is consumer protection?

Answer 22

Makes it illegal for firms to sell dangerous goods or mislead consumers via inaccurate advertising.

Question 23

What is moral hazard?

Answer 23

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.

Question 24

What is the principal-agent problem?

Answer 24

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.