4.1.8 - The Market Mechanism , Market Failure And Government Intervention In Markets

Question 1

Define Competition Policy

Answer 1

Is a government policy which seeks to promote competition and efficiency in different markets and industries

Question 2

Explain what the Competition Markets Authority (CMA) is ?

What do they have the power to do

Answer 2

Uses market structure , conduct and performance to scan the economy and act as a surrogate in a market to make it more competitive.

Can prevent mergers and takeovers
Investigates cartels
Price fixing
Predatory pricing

Question 3

What is the UK regulatory framework

Answer 3

Occurs where regulatory bodies oversee markets which were formally nationalised industries and are now privatised.

They have the power to investigate competition abuses by companies

Question 4

What is the EU regulatory framework

Answer 4

Occurs where the EU intervenes when it involves cross- border trade . A firm that sells its products in several EU countries can be investigated for anti-competitive behaviour

Question 5

Define Government regulations

Answer 5

Are a set of rules which seek to modify the behaviour of firms

Question 6

List all the types of government regulations (9)

Answer 6

Price control 
Profit control
Windfall tax
Quality standards 
Performance targets 
Breaking up monopolies
Lowering barriers to entry 
Subsidies 
Merger policy

Question 7

Explain price control as a method of government regulation

What are examples of it

Advantages and disadvantages

Answer 7

Is where a regulatory authority sets price limits to keep price rises below inflation.

Minimum pricing (reduced demand and increased producer surplus) and maximum pricing (reduced supply and increased consumer surplus) are methods of price control

A: Allocative efficiency, reduces price discrimination
D: Loss of Dynamic efficiency, Deters new entrants

Question 8

Explain profit control as a method of government regulation

What are the problems of this method

Answer 8

Involves fixing a maximum level of profit that a firm can earn. The monopolist would make no more profit than if the market was perfectly competitive.

Requires regulators to have a good understanding of costs and profit in the industry, monopolies have little incentive to minimise costs (x-inefficiency)

Question 9

Explain windfall tax as a method of government regulation

Advantages and disadvantages

Answer 9

Occurs where monopolists make large abnormal profits and governments impose a tax on it

A: can help fund social programs
D: can reduce the profit incentive, dynamic inefficiency

Question 10

Explain Quality standards as a method of government regulation

Answer 10

Occur due to firms being profit maximisers rather than focusing on good quality. The government can set a minimum quality standard which a firm has to follow

Question 11

Explain performance targets as a method of government regulation

Answer 11

Occurs where targets like price charged, quality of products or degree of customer choice are set by regulators. If not met regulator fees are charged

Question 12

Explain breaking up monopolies as a method of government regulation

Answer 12

Reduces monopoly power leading to lower prices and profits

Question 13

Explain Lowering barriers to entry as a method of government regulation

Answer 13

Is done in the hope that new firms will enter the market and increase competition

Question 14

Explain subsides as a method of government regulation

Answer 14

Are given to monopolies to increase production and therefore reduce market price

Question 15

Explain merger policy as a method of government regulation

Answer 15

Involves preventing the merger of two large firms which could have a large market share

Question 16

Define public ownership

Answer 16

Is the government ownership of firms , industry or other assets

Question 17

Define Nationalisation

Answer 17

Is the transfer of assets from the private sector to public ownership

Question 18

What are the arguments for and against nationalisation

Answer 18

For:
Economies of scale- monopoly power leads to reduced unit costs and reduced prices for customers
Increased social welfare- allocatively efficient level of output
Industries like rail, energy and water are too important to be owned privately, who’s main goal is to make a profit
Fairer distribution of resources
Against :
Lack of dynamic efficiency
Lack of expertise in the industry
Reduces competition
Lack of knowledge of changing consumer tastes
Can exert monopsonist power

Question 19

Define Privatisation

Answer 19

Is the sale of government owned assets to the private sector

Question 20

What are the arguments for and against privatisation

Answer 20

For:
Raises extra revenue for the government 
Promotes competition
Promotes efficiency (due to profit incentive) 
Improved choice and quality 

Against :
Exploitation of monopoly power (profit maximisation)
Decreased consumer surplus
Decreased equity

Question 21

Explain Labours plan to Nationalise many different UK industries

Answer 21

Labour wanted to renationalise mail delivery, power grid, water and rail.
Nationalising the water and energy industry would cut household costs by £220 a year
Conservatives argued it would add £14 billion to national debt, however the debt would be balanced by acquiring an asset of equivalent value.
Nationalising would mean reduced financing costs but would be run to gain political benefits

Question 22

Explain Labour’s plan to Nationalise broadband

Answer 22

Labour wanted to nationalise broadband and make it free
Would cost £20-40 billion to nationalise
Would provide equitable distribution
Would cause increased public debt and taxes for consumers
Would reduce costs for businesses who rely on broadband, would also allow increased home working and decreased pollution.
No good examples of nationalised broadband and could damage vital foreign investment into british infrastructure.

Question 23

Define Deregulation

Answer 23

Is the removal of rules and regulations in order to increase the efficiency of markets

Question 24

Define market failure

Answer 24

Exists when the competitive outcome of markets is not efficient

Question 25

Define government failure

Answer 25

Occurs when government intervention leads to a net welfare loss compared to the free market solution

Question 26

What are the types of government failure (6)

Answer 26

``` Distortion of price signals Unintended consequences Excessive administration costs Information gaps Conflicting objectives Regulatory capture ```

Question 27

Explain distortion of price signals as a method of government failure

Answer 27

Occurs where minimum/maximum price fixes lead to a net welfare loss in the market

Question 28

Explain unintended consequences as a form of government failure Give an example

Answer 28

Occurs where some interventions by the government create unintended consequences For example, the common agricultural policy lead to increased food prices for consumers

Question 29

Explain excessive administration costs as a form of government failure

Answer 29

Occurs where the administrative costs of correcting market failure is so large that it outweighs the welfare benefit.

Question 30

Explain information gaps as a form of government intervention

Answer 30

Occurs where governments do not possess complete information to base a decision, may make the wrong policy.

Question 31

Explain conflicting objectives as a form of government intervention Give an example

Answer 31

Occurs where there is an opportunity cost in implementing a policy For example, the government may want to cut taxes but also increase spending on defence.

Question 32

Explain regulatory capture as a form of government intervention

Answer 32

Occurs where the government operates in favour of producers rather than consumers

Question 33

Define public choice theory

Answer 33

Is about how and why public spending and taxation decisions are made

Question 34

Define rent seeking

Answer 34

Is the use of political power by an economic agent to manipulate the distribution of resources for their own benefit.

Question 35

Define Externalities

Answer 35

Are third party costs or benefits from the consumption or production of a product or service

Question 36

What is the formula for marginal social cost What is the formula for marginal social benefit

Answer 36

Private cost + external cost Private benefit + external benefit

Question 37

Define Private cost/benefit

Answer 37

Is the cost/benefit of an activity to an individual economic unit, a consumer or firm

Question 38

What is the Socially optimum level of output Draw graph

Answer 38

Where Marginal social benefit = Marginal social cost

Question 39

# Define Social cost What is the relationship with private costs

Answer 39

Is the cost of an activity not just to the individual unit which creates the cost , but the rest of society as well. If social cost is greater than private cost a negative externality exists

Question 40

Define Demerit goods

Answer 40

Goods which are thought to be bad for you, consumption can lead to negative externalities

Question 41

Why do people over consume demerit goods (6)

Answer 41

``` Temporal myopia (short term thinking) Information failure Information overload Lack of alternatives Addiction Marketing and advertising ```

Question 42

Draw the effect of a a demerit good on a graph

Answer 42

X

Question 43

What are government policy solutions for overconsumption of demerit goods (6)

Answer 43

Minimum price - (alcohol in Scotland) Indirect taxes - excise duty, VAT Providing information - labelling, education, advertising Ban- making products illegal Substitute products - providing alternatives Behavioural economic solutions - cigarettes kept out of sight

Question 44

Define merit goods

Answer 44

Are goods that society values and judges that everyone should have, consumption can lead to positive externalities.

Question 45

What are the characteristics of merit goods

Answer 45

People under consume them The government and private sector provide these goods Social benefit exceeds private benefit Individuals usually have imperfect information on these goods

Question 46

What are examples of merit goods

Answer 46

Pensions Vaccines Education Gym memberships (exercise)

Question 47

Draw a merit good graph

Answer 47

X

Question 48

What are the government policy solutions for underconsumption of merit goods

Answer 48

Behavioural economic solutions - default choices, Mandated choices and nudges Simpler information - improve peoples understanding, presentation of options (e.g. five a day campaign advertising) Providing subsidies - increases supply, cheaper prices for products/services, takes money away from government -> increased tax/debt Government provision - nationalisation of health and education sector Taxing negative alternatives - tax on demerit goods

Question 49

Define Negative Externalities in Production

Answer 49

Are the third party costs of producing a good

Question 50

State examples of negative externalities in production (3)

Answer 50

Pesticides used in farming which pollute rivers Damage to ocean beds from intensive fishing Air pollution caused by manufacturing

Question 51

Draw and explain a negative externalities in production graph

Answer 51

Assumed that the MPB = MSC The market equilibrium level of output is where MPB= MPC Where MSC = MSB is the socially optimum level of output Net welfare loss from producing the market equilibrium output instead of socially optimum level of output

Question 52

What are the policy solutions to reduce negative externalities in production What are the advantages and disadvantages

Answer 52

Tax on production- e.g. pollution tax, congestion charge A: Ring fencing opportunities (congestion charge spent on improving transport) D: Hard to asign right level of tax, producers may move to countries with lower tax -> increased unemployment Subsidising positive externalities in production - Increases their supply and reduces prices, consumers may choose subsidised product over negative production externalities product

Question 53

Define Positive externalities in production

Answer 53

Are the third party benefits of producing a good

Question 54

State examples of positive externalities in production

Answer 54

Building a train station which provides shelter for the homeless A company develops new technology which can be implemented by other firms

Question 55

Draw and explain the positive externalities in production graph

Answer 55

Shows the potential welfare gain by producing the socially optimum level of output instead of the market forces output

Question 56

# Define public goods Explain their characteristics

Answer 56

Are goods which when supplied to one individual is immediately available to others at no charge , are non rival and non excludable Non rival - means that one persons enjoyment of the good does not diminish another persons enjoyment Non excludable - means that non paying customers cannot be excluded from using a good once its been produced

Question 57

State examples of public goods

Answer 57

Street lighting - once produced everyone can use it without charge Flood defences - protecting the coastline from flooding benefits the whole community

Question 58

Why is a public good under provided in the market

Answer 58

Under provided in a free market due to there not being an incentive to pay. Firms may not provide the good as they have trouble charging for it

Question 59

Explain the free rider problem

Answer 59

Is the reason for market failure in terms of public goods . Not possible to prevent anyone from consuming a good, people do not pay for it so producers stop producing it.

Question 60

What are cases for government intervention with public goods

Answer 60

Overcomes the free rider problem Prevents underconsumption , social welfare is improved Government provision allows economies of scale

Question 61

Define property rights

Answer 61

Describes the legal ownership of resources and how they can be used , can be owned by individuals, businesses or governments

Question 62

# Define private goods Explain their characteristics

Answer 62

Are goods and services sold by private sector businesses which are excludable and rival in consumption Excludable - where consumers can be excluded from enjoying a product if they are not willing to pay for it , allowing the seller to make a profit and exercise property rights. E.g. Pay per view events Rival in consumption - where one persons consumption of a good reduces the amount for others to benefit from , scarce resources are used in production

Question 63

State examples of private goods

Answer 63

Private gyms Exclusive clubs Tickets to an event

Question 64

What is the difference between public and private goods

Answer 64

Consumption of a private good reduces the benefit for someone else, a public good has the same amount of benefit for everyone Public goods are available for everyone, private goods are only available for those willing to pay for it.

Question 65

# Define Quasi public goods Explain their characteristics

Answer 65

Is a near public good but does not have all the characteristics. Semi non rival - Beaches are public goods until they become overcrowded and reduce benefit Semi non excludable - toll booths charge for road usage on congested roads

Question 66

What effect do advances in technology have on public and private goods

Answer 66

Causing a blurring of the distinction between public and private goods E.g. Technology allows sporting events which were private goods and excludable to become non-excludable and public goods through live streaming

Question 67

Define environmental market failure

Answer 67

Are negative externalities arising from the over- exploitation of environmental resources

Question 68

Explain the tragedy of the commons

Answer 68

Is the over-exploitation of resources such as oceans, forests or atmosphere that are not owned by individuals or organisations

Question 69

What are the functions of the price mechanism (4) What are their relation to market failure

Answer 69

The Rationing function- increasing prices ration demand to those most able to afford a good or service The Signalling function- prices provide important information to market participants The Incentive Function - increased prices strengthen incentives for firms to produce more to make a profit. The Allocative function- diverts resources to where they can maximise their returns and away from users where they don’t When any of these price functions break down, market failure occurs

Question 70

Define Complete market failure

Answer 70

Occurs when the free market fails to create a market for a good or service, public good

Question 71

Define partial market failure

Answer 71

Occurs when a market exists, but does not provide resources in their optimum quantities , over production/consumption and under production/consumption