1.8 The market mechanism, market failure, and government intervention in markets Flashcards
(99 cards)
1
Q
Market mechanism
A
the process where changes in prices allocate resources
2
Q
Price mechanism
A
changes in price in response to changes in demand and supply have the effect of making demand equal to supply
3
Q
Functions of the price mechanism (4)
A
- allocative
- Rationing
- signalling
- incentive
4
Q
allocative function of price
A
how prices help allocate scarce resources to the most valued uses in a market economy.
If price rises, it signals higher demand or greater scarcity.
Producers are incentivised to produce more.
Consumers may buy less.
If price falls, it suggests lower demand or more availability.
Producers reduce supply.
Consumers are more likely to buy.
5
Q
rationing function of prices
A
rising prices ration demand for a product
6
Q
signalling function of price
A
Prices provide information to buyers and sellers
7
Q
Incentive function of prices
A
Prices create incentives for people to alter their economic behaviour; for example, a higher price creates an incentive for firms to supply more of a good or service.
8
Q
allocative efficiency
A
when resources are allocated efficiently where total economic welfare is maximised
p=mc
msc=msb
9
Q
market failure
A
occurs when the price mechanism fails to allocate scarce resources to the allocatively optimum p does not = mc
or when the market does not exist
10
Q
Partial market failure
A
when there is a misallocation of resources
11
Q
productive efficiency
A
The production of a good in the least costly way
when mc=mr and ac is at its minimum
12
Q
shortage
A
excess demand in a market which is in disequilibrium
13
Q
surplus
A
excess supply in a market which is in disequilibrium
14
Q
equilibrium price
A
price where quantity supplied equals quantity demanded; at this price there is no shortage or surplus
15
Q
black market
A
anywhere where buyers and sellers come together, a price is agreed and an illegal transaction takes place
16
Q
minimum price (price floor)
A
a legal limit on how low a price can be charged for a particular good, in a particular market
17
Q
Effects on a minimum price below equilibrium
A
no effect on price or quantity sold
18
Q
Effects of minimum price above equilibrium
A
price increases, excess supply
19
Q
Maximum price (Price ceiling)
A
a legal limit on how high a price can be charged for a particular good, or in a particular market
20
Q
Effects of Maximum price below equilibrium
A
price falls, excess demand
21
Q
Effects of maximum price above equilibrium
A
no effect on price or quantity
22
Q
Missing market
A
the absence of a market for a good or service, most commonly in the case of public goods and externalities
23
Q
non-excludable + example
A
when it is impossible or very costly to prevent non-paying consumers from benefiting from it.
National defense, Clean air
24
Q
non-rivalrous + example
A
one person’s consumption does not reduce the amount available for others.
National defense
25
private good
a good which has excludability and rivalry
26
public good
a good which has non-excludability and non-rivalry
27
property right
the exclusive authority to determine how a resource is used (e.g. the owner of a chocolate bar has the right to prevent others from consuming the bar unless they are prepared to pay the owner a price)
28
free rider problem
Consumers have no incentive to pay because they can benefit for free (e.g., street lighting, national defense).
This results in under-provision by private markets. because it makes it difficult for firms to make profit
29
quasi-public good + example
a good that has some characteristics of both public and private goods, but not all.
Key Features:
Partially Non-Rival – One person’s use does not fully reduce availability for others (up to a point).
Partially Excludable – It is possible to exclude non-payers, but not perfectly.
E.g Public Parks Free to enter (non-excludable), but can get crowded (rivalrous at peak times).
30
Public goods examples
-National Defence
-Lighthouses
Example: Street Lighting
Non-Rivalrous: One person’s use doesn’t dim the light for others.
Non-Excludable: Pedestrians benefit even if they don’t pay taxes.
Market Failure: Private firms won’t provide it (free-rider problem).
Government Role: Funded by taxation.
31
Tragedy of the commons
a market failure where individuals overuse a shared, rivalrous resource leading to its depletion. This occurs because:
No one owns the resource (non-excludable).
Users act in self-interest, ignoring long-term sustainability.
Real-World Example
Clean Air - resource
Pollution from factories/cars.- problem
Climate change; health costs. - consequence
32
externality
a cost or benefit that affects a third party who is not directly involved in the economic activity (production or consumption) of a good or service.
33
socially optimal output
output where marginal social benefit = marginal social cost; also known as allocatively efficient level of output; if output occurs at any other level, a market failure exists
34
social cost =
private cost + external cost
35
social benefit =
private benefit + external benefit
36
third party
someone not directly involved in a transaction, separate from the seller (first party) and the buyer (second party)
37
negative externality
a cost that is suffered by a third party as a result of an economic transaction
38
positive externality
a benefit that is enjoyed by a third-party as a result of an economic transaction
39
production externality
when production of a good or a service imposes external costs or benefits on third parties outside of the market without these being reflected in market prices.
40
Consumption externality
When consumption of a good or service imposes external costs or benefits on third parties outside of the market without these being reflected in market prices
41
Describe a positive production externality diagram
MSC
42
Describe a Negative Production Externality diagram
MSC>MPC
43
Describe a Positive Consumption Externality diagram
MSB>MPB
44
describe a negative consumption externality diagram
MSB
45
imperfect information
Imperfect information occurs when buyers and/or sellers do not have full knowledge about prices, costs, or benefits of a good or service.
46
merit good
47
demerit good
48
asymmetric information
one party in a transaction has more/better information than the other, distorting outcomes.
49
Adverse selection
AQA-Aligned Examples
Health Insurance Market
Problem: Sick people (who know their health risks) are more likely to buy insurance than healthy people.
Outcome: Insurers raise premiums for all → healthy people drop out → market collapses.
50
factors of production
Inputs into the productive process; land, labour, capital, enterprise
51
factor immobility
when factors of production cannot move between different markets
52
unemployment
occurs when a person who is actively searching for employment is unable to find work
53
geographical immobility of labour
when workers are unwilling or unable to move from one area to another in search of work
54
occupational immobility of labour
occurs when workers find it difficult or impossible to move between jobs because they lack or cannot develop the skills required for new jobs
55
income
the flow of money a person or household receives in a particular time period
56
wealth
the stock of everything which has value that a person or household owns at a particular point in time
57
equality
everyone is treated the same; a completely equal distribution of income means that everybody has the same income
58
equity
everyone is treated fairly
59
progressive taxation
a tax for which, as income rises, a greater proportion of income is paid
60
income tax threshold
the level of income above which people pay income tax
61
absolute poverty
the state of being deprived of basic human needs
62
relative poverty
the state of having an income below a specified proportion of average income
63
national minimum wage
A minimum wage or wage rate that must by law be paid to employees, though in many labour markets the wage rate paid by employers is above the national minimum wage.
64
distribution of income
how income is divided between rich and poor, or between different groups in society
65
distribution of wealth
how wealth is divided between rich and poor, or between different groups in society
66
resource misallocation
when resources are allocated in a way which does not maximise economic welfare
67
complete market failure
the absence of a market for a good or a service
68
monopoly power
ability to influence the ruling market price, output and other aspects such as produc differentiation
69
indirect taxation
Indirect taxes are taxes levied on goods and services, rather than directly on income or profits. They are paid by producers, but the cost is usually passed on to consumers through higher prices.
70
subsidy
a payment made by the government to a producer
71
state provision
the government providing a good
72
regulation
imposition of rules, controls, and constraints, which restrict freedom of economic action in the market place
73
provision of information
providing missing information (e.g. TV adverts on the dangers of drinking)
74
government failure
occurs when government intervention leads to a net welfare loss compared to the free market solution
75
5 sources of government failure
- regulatory capture
- imperfect information
- conflicting objectives
- administration costs
- unintended consequences
76
regulatory capture
occurs when regulatory agencies act in the interest of regulated firms rather on behalf of the consumers they are supposed to protect.
77
conflicting objectives
in attempting to achieve one outcome, another is sacrificed
eg Example: Economic Growth vs. Environmental Protection
✅ This creates jobs and income…
❌ But it often causes pollution, resource depletion, and carbon emissions.
78
administration costs
expenses associated with the management and execution of a policy
If administration costs are too high, they can:
Outweigh the benefits of the intervention
→ The cost of enforcing a policy might be greater than the problem it’s trying to fix.
Waste taxpayer money
→ Money could be spent more efficiently elsewhere.
79
unintended consequences
outcomes that are not the ones foreseen and intended by a purposeful action
eg black market
80
intellectual property right
Intellectual Property Rights are legal protections given to creators or inventors to ensure they can control and profit from their creations, inventions, or ideas.
81
Patent
gives its owner the right to exclude others from making, using, selling, and importing an invention for a limited period of time, usually twenty years
82
Copyright
Copyright is a type of intellectual property right that gives legal protection to creators of original works such as books, music, films, software, or artwork. It allows them to control how their work is used and to earn income from it.
83
trademark
the exclusive authority to determine how symbols or words legally representing a firm or product are used
84
Royalty
a sum paid to a patentee for the use of a patent or to a copyright holder for each copy of a work sold and/or publicly performed
85
Moral hazard
86
Tradable pollution permits
each firm is given a permit to produce a given level of pollution. If less than the permitted amount is produced, the firm is given a credit. This can then be sold to another firm, allowing it to exceed its original limit.
87
The competition and markets authority (CMA)
government agency responsible for advising on and implementing UK competition policy
88
Competition policy
the part of the government's microeconomic policy and industrial policy which aims to make goods markets more competitive. It comprises policy toward monopoly. mergers and restrictive trading practices.
89
consumer inertia
the tendency of some consumers to buy or continue buying a good, even when superior options exist
90
Advantages of privatisation (3)
Increased Efficiency
Private firms have a profit motive, encouraging them to reduce costs and improve productivity.
They are more likely to innovate, streamline operations, and cut waste compared to public sector firms.
Revenue for the Government
Selling public assets brings in short-term revenue.
This can be used to reduce national debt or fund other public services.
Improved Quality and Choice
Private firms often face market competition, pushing them to improve service quality and offer more consumer choice.
91
Disadvantages of privatisation (2)
exploit their market power:
Higher prices
Lower service quality
Private firms focus on profit, not public welfare.
Can lead to:
Job cuts
Ignoring social objectives (like access for rural areas or disabled people)
Short-term profit thinking over long-term investment
92
Nationalisation
the transfer of industries, firms or other assets from private ownership to public ownership
93
privatisation
the transfer of industries, firms, or other assets by public ownership to private ownership
94
Alternative approaches to the problem of monopoly (5)
- compulsory breaking up on monopolies
- use of price controls to restrict monopoly abuse
- taxing monopoly profits
- state ownership of natural monopolies
- deregulation and the removal of barriers to entry
95
Private good example
Example: A Chocolate Bar
Rivalrous: If you eat it, no one else can.
Excludable: Only those who pay can consume it.
Market Provision: Supplied efficiently by private firms (e.g., Cadbury).
96
price floor
unintended consequences E.g black market
IB - intervention buying
deadweight loss abd
97
price ceiling
consumers- excess demand
producers- leave market- contraction of supply
98
nationalisation
When the government takes ownership and control of a private sector business or industry, making it part of the public sector.
✅ Key features:
Owned and run by the state.
Operated in the public interest (rather than profit motive).
Common in natural monopolies (e.g. railways, water, energy).
Funded by taxpayer.
✅ Why nationalise? (economic reasons):
Prevent monopoly abuse.
Ensure universal access (e.g. transport, utilities).
Correct market failure (externalities, under-provision).
Maintain strategic control (over key industries).
✅ Potential drawbacks:
❌ Lack of profit motive → risk of X-inefficiency (wasteful costs, no pressure to cut costs).
❌ Political interference in business decisions.
❌ High financial cost for taxpayers to buy industries.
99
windfall tax
A one-off tax imposed by the government on firms that have earned unexpectedly high (supernormal) profits, usually due to external factors rather than their own efforts.
👉 It’s temporary and targeted at industries making unusually large profits.
✅ Why impose a windfall tax?
Governments use windfall taxes to:
✅ Raise revenue without raising regular taxes.
✅ Redistribute profits earned due to external events (e.g. global price spikes).
✅ Fund public spending or subsidies (e.g. help with energy bills).
✅ Address public concerns over “excessive profits.”
✅ Real-world example:
In 2022, the UK government introduced a windfall tax on oil and gas companies after global energy prices surged → used funds to help households cope with rising energy bills.
-
Key Links
-
Subjects
-
Company
-
Find Us
-
