4 - Market Failure Flashcards
(15 cards)
Define ‘market failure’
When free market mechanism does not lead to an optimal allocation of resources.
Define ‘externality’
Cost or benefit that is external to the market, thus is not reflected in market prices.
Define ‘public good’
When good is non-excludable and non-rival in consumption.
Define ‘private good’
When good is excludable and rival in consumption.
Define ‘quasi good’
When good is neither completely private nor public good.
Define ‘free rider problem’
When an individual cannot be excluded from consuming a good and thus has no incentive to pay for its provision.
Define ‘asymmetric information’
Situation where some participants in the market have better better conditions than others.
Define ‘merit goods’
Goods that bring unanticipated benefits to consumers
Define ‘demerit good’
Good that bring less benefit to individuals than they expected
Define ‘moral hazard’
Person who more willing to take risk because someone else is bearing the cost
Define ‘adverse selection’
Person at risk likely to take out insurance.
Define ‘private cost’
Cost incurred to the consumers and producers that were directly involved in the economic transaction.
Define ‘external cost’
Cost to the third market and not included in the market transaction, thus not reflected in the market price.
Explain social cost
Private cost + external cost
Explain how under-provision of public goods leads to market failure
Private firms will not produce goods that are not rivalrous and non-excludable in consumption because of the free rider problem.
This means that individuals cannot be excludable from consumption, hence has no incentive to pay for its provision.
Hence, these goods are underproduced. Welfare is loss.
