The market mechanism, market failure and government intervention

Question 1

What are the main functions of price in a competitive market?

Answer 1

Rationing function
Incentive function
Signalling function

Question 2

What does a misallocation of resources lead to?

Answer 2

Market failure

Question 3

When does complete market failure occur?

Answer 3

When no market for a good exists

Question 4

When does partial market failure occur?

Answer 4

When there is a market for a good but resources are not allocated in a way to maximise social welfare

Question 5

What causes market failure?

Answer 5

Public goods
Positive/negative externalities in consumption and production
Merit/demerit goods
Monopoly
Income and wealth gap
Immobility of factors of production
Imperfect information

Question 6

What is a private good?

Answer 6

A good where consumption is only available for one person

Question 7

Name the two key features of public goods

Answer 7

Non-rival

Non-excludable

Question 8

What is the free rider problem?

Answer 8

The problem of people enjoying the benefit of a public good without paying for it

Question 9

What is an externality?

Answer 9

The effect of an economic decision on other people/organisations

Question 10

Give an example of a positive externality in consumption

Answer 10

Vaccinations - less chance of an epidemic

Question 11

Give an example of a negative externality in consumption

Answer 11

Cigarette smoke - causing discomfort/illness for non-smokers

Question 12

Give an example of a positive externality in production

Answer 12

Training - more skilled workers

Question 13

Give an example of a negative externality in production

Answer 13

Noise pollution from factories

Question 14

What is a merit good?

Answer 14

A good which is underprovided by the market mechanism

Question 15

What is a demerit good?

Answer 15

A good which is overprovided by the market mechanism

Question 16

Why do merit and demerit goods arise?

Answer 16

Consumers do not take externalities into account, and consumers may be unaware of the long-term consequences of consumption

Question 17

What is symmetric information?

Answer 17

When both the seller and buyer of a product are well informed of the product and the prices in the market

Question 18

What is asymmetric information?

Answer 18

When either the seller or buyer of a product has more information than the other

Question 19

What does the degree of monopoly power depend on?

Answer 19

Degree of market concentration
PED
Barriers to entry
Brand loyalty/product differentiation

Question 20

Name and describe the two forms of immobility

Answer 20

Geographical - when the resources can not move from one place to another
Occupational - when the resources can not change their job

Question 21

What is income?

Answer 21

A flow of money received over a period of time

Question 22

What is wealth?

Answer 22

A stock of assets accumulated over a period of time

Question 23

What are the main methods of government intervention?

Answer 23

State provision of a good/service
Indirect taxation (VAT)
Subsidies
Price controls
Regulations
Public expenditure/direct taxation (Income tax)

Question 24

List the main reasons for government failure

Answer 24

Inadequate information
Conflicting objectives
Administrative costs