2.4 Market Failure

Question 1

Allocative Efficiency (when)

Answer 1

Resources are allocated efficiently when it is NOT possible to benefit one person without making someone else worse off

Question 2

Technical (productive) efficiency

Answer 2

when firms pursue the least cost method of production. Where firms produce at minimum average cost

Question 3

Allocative (economic) efficiency

Answer 3

where resources are allocated into their best use. Where price equals marginal cost.

Question 4

Marginal Cost

Answer 4

is the cost to society of all the scarce resources in producing a good, including risk taking for profit

Question 5

Market Failure

Answer 5

is the situation in which the free market leads to under-allocation or over-allocation of resources to a specific good or service, leading to an overproduction, under production, over consumption, or under consumption

Question 6

Pareto optimality

Answer 6

“socially efficent” Market is an equilibrium with no external influences/effects

Question 7

What is the socially optimal output?

Answer 7

where MSC = MSB, where social/community surplus is maximised and where allocative efficiency occurs.

Question 8

Non - rivalrous public goods

Answer 8

many users can consume the goods at the same time

Question 9

Non - exclusive public goods

Answer 9

no one can be excluded from its use

Question 10

What can a government do to intervene in response to a need for public goods?

Answer 10

direct provision
contracting out to the private sector

Question 11

Common access resources (def)

Answer 11

the ‘gifts of nature’ over which there is no private ownership and therefore no effective means of regulating use of the resourceE

Question 12

Examples of common access resources

Answer 12

fish in the sea
trees in a forest
common pastureland
the air we breathe

Question 13

What is the tragedy of the commons

Answer 13

lack of ownership creates an incentive for potential users to exploit them to the fullest extent possible, so as to extract as much benefit as possible before other extract and exploit the resource.

Question 14

Privatization

Answer 14

assigning private ownership over a resource to create an incentive amongst private owners to protect and manage it sustainably.

Question 15

Government management

Answer 15

control over access and use it to limit it to sustainable usage

Question 16

Tradeable permits

Answer 16

issuing permits to private users to allow a certain amount of extraction in a period of time to limit exploitation and maintain sustainable usage

Question 17

Merit good

Answer 17

refers to a private good that has positive externalities associated with its consumption

Question 18

Demerit good

Answer 18

refers to a private good that has negative externalities associated with its consumption

Question 19

Asymmetric Information in reality

Answer 19

decisions are based on incomplete information
one has more information than the other

Question 20

Government solution to asymmetric information

Answer 20

legislation
regulation
provision of information

Question 21

Opportunistic behavior

Answer 21

this is when one party takes advantage of the fact that the other party lacks information. It reults in adverse selection or moral hazard.

Question 22

Adverse selection

Answer 22

A form of opportunistic behavior that refers to the undesired decisions or results of decisiosn when buyers and sellers have access to different information. It distorts price and quantity.

Question 23

Moral Hazard

Answer 23

A situation where a party protected from risk behaves differently than if they were fully exposed to the risk. This can impose costs on the other party that has less information. thsi means the consequences of one’s actions are borne by society as a whole or by a third party, rather than by the individual himself.

Question 24

Private responses to asymmetric information

Answer 24

signalling and screening

Question 25

signalling

Answer 25

a strategy undertaken by the party with more/superior information to maximize own return/utility

Question 26

Screening

Answer 26

A strategy underatken by parties with less/inferior information to maximize their own return/utility. this means screening out biased, inaccurate or misleading information.

Question 27

Abuse of monopoly power in imperfect competition

Answer 27

monopoly: we assume that all firms aim to maximize profit. Therefore in the absence of competitions, monopolists will have incentive to restrict output and push up price. Welfare loss: community surplus is not maximized

Question 28

Government actions for imperfect competition

Answer 28

regulation nationalization trade liberalization regulatory bodies

Question 29

Wealth

Answer 29

the stock of economic goods and services owned and measured at a particular point in time

Question 30

Income

Answer 30

the flow of economic payments

Question 31

Government solutions to income issues

Answer 31

Taxation system (NOTE - altering the progressive system is the solution to income inequality) - progressive taxation, proportionate taxation, regressive taxation Transfer payments

Question 32

progressive taxation

Answer 32

where the rate of tax increases the higher the income

Question 33

proportionate taxation

Answer 33

where the rate of tax is proportionate to income

Question 34

regressive taxation (e.g. indirect tax)

Answer 34

where the rate of tax decreases the higher the income

Question 35

transfer payments

Answer 35

when the government transfers income from one group of the population to another through taxation and benefits

Question 36

Factors of production in a perfect market

Answer 36

resources move easily between uses for higher FOP usage

Question 37

FOP in reality

Answer 37

shortages time lags lack of factor substitutes especially lack of labour mobility

Question 38

Government solutions to FOP

Answer 38

retraining schemes move to workers/workers to work

Question 39

Short termism in a perfect market

Answer 39

effects are immediate, or there is not effect

Question 40

short termism in reality

Answer 40

short term decisions with long term problems private sector - resource and sustainability public sector - elections, demerit goods

Question 41

Externalities

Answer 41

goods produced external to the price mechanism refers to a spillover in production or consumption that arises in social costs or benefits from a firm or individual undertaking an economic activity.

Question 42

Negative externality of production

Answer 42

refers to a spillover in production that arises in social costs when a firm undertakes an economic activity.

Question 43

Solutions to neg. ext. of prod.

Answer 43

taxation fines legislation/government regulations tradeable permits (allocating property rights)

Question 44

neg. ext. of prod. solution: taxation shift?

Answer 44

shift supply curve inwards which will increase price and decrease output. because a firm is producing less of the good, less spillovers of production will be produced as well, and the existence of the externality will decrease or disappear. Welfare loss is reduced or eliminated.