Market mechanism, market failure, and government intervention

Question 1

How does the price mechanism allocate resources?

Answer 1

1. Rationing - prices increase where there is scarce resources and excess demand, so as it ration resources and decrease demand.
2. Signalling - prices signal where resources are scarce or needed.
3. Incentives - prices encourage changes in behaviour of producers or consumers.

Question 2

What is market failure?

Answer 2

Market failure occurs when there is a misallocation of resources - resources are not allocated to best interests, meaning economic and social welfare is not maximised.

Question 3

What are the different types of market failure?

Answer 3

1. Externalities.
2. Under-provision of public goods.
3. Information gaps.
4. Monopolies.
5. Inequalities in distribution of income and wealth.

Question 4

What is complete market failure?

Answer 4

When there is a ‘missing market’. Products are not supplied.

Question 5

What is partial market failure?

Answer 5

When the wrong quantity of products is supplied, meaning misallocation of resources.

Question 6

What is an externality?

Answer 6

A cost or benefit to a third party created by economic activity.

Question 7

Income vs wealth

Answer 7

Income is a flow of money, wealth is a stock of assets.

Question 8

What is a public good?

Answer 8

A good that is both non-excludable and non-rival. Public goods are underprovided in the private sector due to the free-rider problem, and so are generally provided by governments.

Question 9

What is non-excludability?

Answer 9

When one person consumes a good, others are not prevented from consuming the good.

Question 10

What is non-rivalry?

Answer 10

When more people consume the good, the benefit other people get does not diminish.

Question 11

What is a private good?

Answer 11

Goods that are both rival and excludable.

Question 12

What is a Quasi-public good?

Answer 12

A quasi-public good, or non-pure public good, is a good which is partially provided by the free market and is not fully non-rival and non-excludable.

Question 13

What are private costs and benefits?

Answer 13

Private costs are the costs of production producers must pay.
Private benefits are the benefits derived from consumption of a good.

Question 14

What are external costs and benefits?

Answer 14

External costs and benefits are the costs and benefits that occur during production and consumption - they are the externalities. These are ignored by market equilibrium, meaning external costs are overproduced and over provided, and external benefits are underproduced and under provided.

Question 15

What are social costs and benefits?

Answer 15

Social costs and benefits are the private costs/benefits + the social costs/benefits.

Question 16

What are demerit goods?

Answer 16

Goods that cause negative externalities. They are associated with information failure, and so are often overprovided and overconsumed.

Question 17

What are merit goods?

Answer 17

Goods that cause positive externalities. They are associated with information failure, and so are often underprovided and underconsumed.

Question 18

The extent of market failure involves value judgement, so it is hard to determine the monetary value of an externality - different people will put different values on it.
Not all products resulting in positive or negative externalities in consumption are merit or demerit goods

Answer 18

The extent of market failure involves value judgement, so it is hard to determine the monetary value of an externality - different people will put different values on it.
Not all products resulting in positive or negative externalities in consumption are merit or demerit goods

Question 19

What is symettric information?

Answer 19

Symettric information means that producers and consumers have perfect market information to make decisions, leading to an efficient allocation of resources.

Question 20

What is asymettric information?

Answer 20

Asymettric information leads to market failure, due to unequal knowledge between producers and consumers, which can create a misallocation of resources.

Question 21

What is the mobility of labour?

Answer 21

The mobility of labour is the ability of labour to move between jobs.

Question 22

What is geographical immobility?

Answer 22

The immobility of factors of production due to obstacles preventing movement between areas.

Question 23

What is occupational immobility?

Answer 23

The immobility of factors of production due to obstacles preventing factors of production finding new use.

Question 24

How can inequitable distribution of income and wealth be reduced?

Answer 24

Government intervention, included progressive taxes and government spending.

Question 25

What is government intervention?

Answer 25

When governments intervene to help correct market failure.

Question 26

What are examples of government intervention?

Answer 26

1. Indirect taxes - Ad Valorem or specific taxes.
2. Subsidies.
3. Maximum and minimum prices.
4. Tradeable pollution permits, or taxes on pollution
5. State provision of public and merit goods
6. Provision of information
7. Regulation