8 Market Failure and Government Intervention Flashcards
(572 cards)
1
Q
What are the 4 functions of prices?
A
- Signalling function
- Incentive function
- Rationing function
- Allocative function
2
Q
What is the signalling function of prices?
A
When prices provide information to buyers and sellers.
3
Q
What information might be signalled through the price mechanism?
A
The scarcity or quality of the fruit.
4
Q
What is the incentive function of prices?
A
When 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.
5
Q
Which phenomenon is responsible for increased supply which leads to the price mechanism working?
A
Incentive function of prices to suppliers.
6
Q
What is the rationing function of prices?
A
Rising prices ration demand for a product.
7
Q
What phenomenon is responsible for demand contracting as the price rises as per the price mechanism?
A
Rationing function of prices.
8
Q
What is the allocative function of prices?
A
High prices allocate resources to those who value them the most.
Absolutely not.
9
Q
In a pure market economy, what allocates scarce resources?
A
Price mechanism alone.
10
Q
What are 3 benefits of the price mechanism?
A
- Consumer sovereignty - only consume what you want.
- Productive efficiency - firms lower average cost per unit.
- Allocative efficiency - price mechanism produces as people want - maximise gain to economic welfare.
11
Q
When does the price mechanism not work?
A
When the markets are not perfectly competitive.
12
Q
What are 3 disadvantages of the price mechanism?
A
- Imperfect competition in markets - asymmetric market information and market power leads to firms not producing the goods/services consumers want - not an allocatively efficient outcome.
- Value neutral - merit goods not subsidised.
- Market failures.
13
Q
What are 2 arguments of free market economists?
A
- Market efficient.
- Government failure risk.
14
Q
Who are interventionist economists?
A
Economists who value intervention in markets.
15
Q
What information is signalled by prices which leads to the incentive function?
A
RELATIVE information - creates incentives to change.
16
Q
What is the term for an imperfectly competitive market dominated by one firm?
A
Monopoly.
17
Q
Why does the price mechanism dysfunction in an imperfectly competitive market such as a monopoly?
A
No incentive for firms to change their behaviour.
18
Q
What is market failure?
A
When the price mechanism leads to a misallocation of resources in the economy.
19
Q
What are the 2 types of market failure?
A
- Complete market failure.
- Partial market failure.
20
Q
Complete market failure is characterised by…
A
Missing markets or complete dysfunction.
21
Q
Partial market failure is characterised by…
A
The ‘wrong’ quantity of goods being allocated.
22
Q
What happens when we charge people to donate bone marrow and what is this an example of?
A
People may stop donating.
Perverse reaction to incentive function of prices.
23
Q
Ignoring inequality as a cause of market failure, what must have gone wrong with the price mechanism to create market failure?
A
One of the four functions has broken down.
24
Q
What do we mean by a misallocation of resources?
A
Not achieving the socially optimum outcome i.e. the outcome which maximises the improvement in social welfare.
25
Give an example of a good that would experience complete market failure if left to the price mechanism?
Nation's armed forces - this cannot have a market.
26
Give an example of a market which may partially fail?
Private healthcare market.
27
Example of the rationing function of prices breaking down?
Alcohol was super cheap in the 1800s.
28
What was the average alcohol consumption in the US in the 19th century?
Over 1 litre of hard spirits a week.
29
What is a highly concentrated market?
A market where a small number of firms control a high proportion of the market share.
30
What are the 9 TYPES OF MARKET FAILURE?
1. Negative externalities.
2. Production externalities.
3. De-merit goods.
4. Merit goods.
5. Public goods.
6. Common access resources.
7. Income inequality.
8. Monopoly power/uncompetitive markets.
9. Factor immobility.
31
Example of unstable commodities markets causing market failure?
In 2008 cereal prices soared. This created uncertainty for investors. The incentive function of prices in other agricultural markets broke down as investors were unsure as to whether productivity would remain high or fluctuate.
32
What occurs between private/social costs and benefits when there are externalities?
They are different.
33
What is an example of a missing market?
Externality.
34
Give an example of a positive externality?
Good view.
35
Why are externalities market failure?
They cannot be included in the free market equilibrium price, hence the price is either too low or too high, hence the allocatively efficient outcome cannot be achieved.
36
Who experiences externalities and how does this contribute to the market failure?
Third parties.
## Footnote
External to the market transaction.
37
Negative externalities formula?
Social Costs = Private cost + External cost.
38
Positive externalities formula?
Social benefit = Private benefit + External benefit.
39
Social cost > Private cost when...
Negative externalities exist.
40
Example of positive externalities?
Vaccine - social benefit is the herd immunity effect, but consumers only pay for the private benefit of their vaccination.
41
Example of a negative externality in production.
Coal-burning power station pollutes the surrounding air.
42
Why is electricity too cheap?
Negative externalities not internalised in the market price.
43
Example of positive production externalities?
Farmers creating a positive view.
44
2 examples of negative externalities in consumption?
1. Inhaling second hand smoke from a cigarette smoker.
2. Victim of dangerous driving.
45
Which cost - private or external - is included in the price mechanism? Which is omitted?
Private in.
External out.
46
It is an example of ____ market failure when organs are overpriced on the free market.
Partial.
47
Example of a positive externality in consumption?
The atmosphere at a football game.
## Footnote
Or the benefit if you were unvaccinated from herd immunity.
48
Are negative consumption externalities the same for everyone?
No, you might like the inconsiderate music person's music.
49
Example that shows that positive externalities in production may not always be positive?
Let's say warm water discharge from a power station didn't just increase fishing stocks but also led to algae pollution.
50
Why can firms under-produce electricity when they cannot charge for the warm water?
Production costs too high - price not at the optimum.
51
What effect do production externalities have and why?
Create market failure as socially optimum quantity not provided.
## Footnote
External costs of production are not internalised.
52
What is the Coase theorem and what does it show?
Establish property rights may lead to the same outcome.
## Footnote
If owning something is required to produce externalities, firms merely buy it, internalise the cost, but the outcome is the same.
53
What is the tragedy of the commons and the example?
Shared property rights often fail because there is no incentive to manage the factors of production.
## Footnote
For instance, common grazing sheep land became exhausted in Victorian Britain because people were incentivised to increase flocks and because nobody owned the land, no one was incentivised not to degrade the soil.
54
Another major example of an industry that has fallen victim to the tragedy of the commons?
Fishing - despite some regulation, the sea is a public good and overfishing is not internalised by anyone.
55
Who challenged tragedy of the commons theory? What evidence?
Elinor Ostrom, won the Nobel Memorial Prize in Economics.
## Footnote
Non-tragedy of the commons exists in Indonesia, Kenya and Nepal studying communally owned farms - she found that those who live in proximity and depend on the communal resource treat it better.
56
How are negative externalities in production and the tragedy of the commons linked?
Pollution of the land cannot be prevented because the land is communally owned - the firms internalise no cost because the land isn't theirs, but if everyone did it, firms would incur a cost.
57
Who is affected by externalities?
Third parties.
58
For positive externalities, MSB =
MPB + MEB.
59
For negative externalities, MSC =
MPC + MEC.
60
What is welfare loss triangle also called?
Deadweight loss (units).
61
What was the Green Deal? What was the problem? How was it fixed?
Green Deal was the government's plan to correct the market failure of underconsumption of energy saving devices such as double glazing and loft insulation.
## Footnote
Subsidies and taxes weren't working. Gave people loans (temporary 100% subsidy) because people had loss aversion bias and wanted things for free. Behavioural insights at work.
62
Example of government failure in the Green Deal?
Some of the assessors deciding eligibility for certain Green Deal programmes allegedly did their jobs badly.
63
Example of how regulation can correct negative production externalities?
Clean Air Act 1956 after 1952 smog - sulphur dioxide in the atmosphere fell in direct proportion to deaths in the coming years.
64
Utility theory assumes we only worry about our own losses and gains. When does private benefit maximisation occur?
When MPB = MSC.
65
True or false - private benefit is maximised when it is equal to private cost.
FALSE.
## Footnote
MARGINAL private benefit = MARGINAL private cost - here, the gap between benefit and cost is at its largest.
66
Draw a marginal analysis diagram to show the market failure when a firm produces pollution.
Divergent cost lines please.
67
When there are externalities in production, the ____ moves.
Marginal cost.
68
When there are externalities in consumption, the _____ moves.
Marginal benefit.
69
Thing to always point out when describing over/under production due to externalities?
The deadweight welfare loss triangle.
70
What is the relationship between MSC and MSB for units in the welfare loss triangle?
MSC > MSB.
## Footnote
DON'T PRODUCE.
71
Draw a diagram for negative production externalities. Show what would have to happen for the deadweight welfare loss to be eliminated.
1. Divergent lines, MSC behind MPC. A line MPB=MSB from top left to top right. P1-Q1 free market equilibrium and P2-Q2 where MSB=MSC. Q1-Q2 = units overproduced, show the welfare loss triangle, price must rise from P1 to P2.
72
Show the welfare loss triangle on a positive production externalities graph.
Units that SHOULD'VE BEEN produced.
73
What are the 4 requirements for achieving allocative efficiency?
1. Competitive markets for all goods and services.
2. No economies of scale.
3. Markets were simultaneously in equilibrium.
4. No externalities.
## Footnote
When P = MC then allocative efficiency is achieved.
74
Why can allocative efficiency not be achieved when externalities are generated?
The full social costs of a good/service are not internalised.
75
Why is allocative efficiency not achieved when a good with negative production externalities is over-produced?
Too many scarce resources put into this good/service because external costs not internalised.
76
The marginal private cost of producing an extra unit of a good is 15, and the marginal external cost resulting from the pollution incurred in the course of production is 3 for each extra unit. Presuming no externalities in consumption, ceteris paribus, what price should achieve allocative efficiency?
18.
77
Ceteris paribus, when does allocative efficiency occur relating to marginal social cost?
When P = MSC.
78
Why is public transport over-priced compared to driving a car in congestion? What does this demonstrate?
Public transport users internalise all costs in their fee - the private road user does not internalise the external costs caused by congestion.
## Footnote
We need to subsidise rail travel to externalise the costs again, this time to the government, so that it can rival the lower marginal private costs of road travel.
79
Positive consumption externality graph?
BBBBB.
80
Negative consumption externality graph?
BBBBB.
81
Positive production externality graph?
BBBBB.
82
Negative production externality graph?
BBBBB.
83
Demand curves in marginal analysis become...
Marginal benefit curves.
84
Supply curves in marginal analysis become...
Marginal cost curves.
85
Who ensures that MPC=MPB?
Private economic agents.
86
Who is responsible for achieving MSB=MSC?
Government.
87
What will consumers account for when deciding how much of a good or service to consume (assuming no intervention)?
Marginal private benefit.
88
What will producers account for when deciding how much of a good or service to consume (assuming no intervention)?
Marginal private cost.
89
What is the market failure in the provision of merit goods?
PARTIAL market failure - they are under-provided.
90
What are the two defining properties of merit goods?
1. Positive consumption externalities.
2. Information failures preventing consumption up to the point where MSC=MS.
91
What is the cause of the information failure in the consumption of merit goods?
Long-term private benefits of consumption exceed short-term benefits - bounded rationality of consumers causes us not to consider the private benefits later.
92
How do we decide if something is a merit good?
Normative value judgement.
93
Draw a diagram to show how a merit good is under-produced and how to fix it using subsidies. What is the value of the subsidy?
The gap between the two intersections.
94
What is the key property of demerit goods?
Social benefit < private benefit.
## Footnote
Social costs = Private costs + External costs.
95
What are 2 key properties of demerit goods?
1. Information failure about their consumption.
2. MSB > MP.
96
What is the graph for a demerit good?
Negative consumption externality.
97
What is the point with information failure and the consumption of demerit goods? What is the name we give?
Ignorance about the future negative consequences of consumption not valued correctly.
## Footnote
INTERNALITIES not considered.
98
Information failure in the consumption of merit and demerit goods causes consumers to...
Incorrectly assess MP.
99
Example of a merit good?
Education.
100
How can Coase Theorem correct externalities?
If everyone owns the land then externalities cannot be discharged because someone would be owed money.
101
Goods which suffer from the tragedy of the commons have what properties?
Rival.
Non-excludable.
102
How can the Coase Theorem fix the tragedy of the commons?
Assign property rights so that it becomes EXCLUDABLE.
103
Why would the allocatively efficient outcomes be achieved if everything was privately owned?
The full external costs would be internalised in the cost of production.
104
Example of a debatable merit good?
Contraceptives.
## Footnote
Do the social benefits supersede the private benefits?
105
What are the 2 angles on the issue of under/over consumption of merit/demerit goods?
1. Consumers fail to estimate the private benefit correctly.
2. Consumers fail to value the social benefit.
106
Do all economists believe in merit goods, demerit goods or potentially even market failure as a concept?
No.
## Footnote
Libertarians.
107
What are the 3 political stances in economics to know?
1. Libertarians - market failure should not be corrected, or concepts such as market failure are not important.
2. Behavioural economists - market failure can be corrected but by using soft regulation such as nudges.
3. Anti-lib.
108
What is a reason for overconsumption of merit/demerit goods?
Consumers fail to estimate the private benefit correctly.
109
Do all economists believe in merit goods, demerit goods or market failure?
No.
110
What are the three political stances in economics?
1. Libertarians - market failure should not be corrected.
2. Behavioural economists - market failure can be corrected using soft regulation.
3. Anti-libertarians - market failure should be corrected through regulation.
111
What does the negative production externality show?
The vertical distance between the two marginal benefit curves.
112
If we set a tax to internalise external costs, what must the value of the tax be identical to?
The value of the external cost.
113
What are two facts that show smoking is bad?
1. Smokers will die on average 10 years earlier than their peers.
2. 50% of smokers die from a smoke-related condition.
114
How can the external cost difference between marginal benefit curves be expressed in negative consumption externalities?
Negative benefit.
115
What graph shows prohibition being the right choice for consumption externalities?
The MSB intercepts the MSC at zero quantity.
116
What is an example of internalities due to information failure?
A teenager starts smoking, neglecting long-term health risks.
117
What is moral hazard?
Moral hazard is the tendency of people who are insured to take more risks.
## Footnote
Example: Healthcare insurance.
118
What can moral hazard cause?
Market failure due to overconsumption of health insurance.
119
What can adverse selection cause?
Market failure due to overconsumption of health insurance by the most ill.
120
How can factor immobility lead to market failure?
It prevents scarce factors of production from being employed properly, leading to inefficiency.
## Footnote
Example: Occupational immobility.
121
What are two ways the government can combat factor immobility of labour?
1. Training schemes.
2. Reforms to the housing market.
122
How could the government operate a command and control policy to reduce market failure?
By bringing industries into public ownership, like the NHS.
123
What is economic regulation?
Government economic policy that directly restricts the free market.
124
What are two types of regulation?
1. Self-regulation.
2. External regulation.
125
What are two advantages of deregulation?
1. Removal of unnecessary production costs.
2. Promotion of competition leading to lower prices.
126
What is contestable market theory?
Regulation reduces market competitiveness.
127
What is an example of regulatory capture?
An Oflot chairman receiving free air travel from a lottery firm.
128
How is regulatory capture government failure?
Regulatory authorities fail to enforce MSB=MSC.
129
What are two reasons for regulatory capture?
1. Information comes from regulated organisations.
2. Close contact with producers may lead regulators to forget consumer views.
130
What do pro-free market economists believe?
The price mechanism achieves better allocation of scarce resources than the government.
131
What do interventionist economists believe?
Government intervention allocates scarce resources better than the free market.
132
What is the most extreme form of regulation?
Complete government control of scarce resource allocation.
133
How can subsidies correct the market failure of under-consumption of merit goods?
Merit goods have positive externalities in consumption, hence they are under-consumed.
134
What are three examples of regulation?
1. Prohibition.
2. Taxation.
3. Quantity control.
135
What is prohibition known as?
Market replacement.
136
How can taxes help absorb production externalities?
By internalising the full external cost through taxation.
137
When a tax is applied, MSC equals what?
MPC + Tax.
138
What are three issues with taxes?
1. Regressive impact on lower income earners.
2. Politically inviable.
3. Creates incentives for firms to evade taxation.
139
Is an ETS a market-oriented solution?
Yes, as it is tradeable.
140
What is an ETS an example of?
Tradeable permit scheme.
141
How does a tradeable permit scheme work?
1. Manufacturers are issued permits.
2. Permits can be sold to other firms, creating incentives to reduce production externalities.
142
What are three issues with tradeable permit schemes?
1. Wealthy firms can emit above social equilibrium if permit prices are too low.
2. Unenforceable.
3. Regressive costs shifted to consumers.
143
What graph shows the long-term trajectory of trading schemes?
Two curves, one to the left, with a demand curve showing price increases.
144
What is the effect of a price ceiling?
Encourages greater demand.
145
What are three main issues with price ceilings?
1. Create black markets due to shortages.
2. Disrupt incentive function of prices.
3. Likely to cause corruption.
146
Do price floors on labour cause surplus in practice?
No, demand for workers is inelastic.
147
What are three flaws of the price floor?
1. Shores up uncompetitive firms.
2. Creates surplus.
3. Encourages illegal sales.
148
What is government failure?
When government intervention to correct market failure either aggravates it or fails to correct it.
149
What are three causes for government failure?
1. Unintended consequences.
2. Administrative costs.
3. Pursuit of conflicting policy objectives.
150
What is an example of conflicting policy objectives leading to government failure?
Construction of HS2 conflicting with later policy goals.
151
Why are administrative costs a cause of government failure?
The cost of monitoring regulation may exceed the benefit of eliminating the externality.
152
What is an example of unintended consequences causing government failure?
Prohibition in the USA during the 1920s.
153
What is the primary example of government failure?
Black markets.
154
What other labour market failure occurs besides factor immobility?
Asymmetric information.
155
How can public information campaigns correct market failure?
By removing imperfect information.
156
What informational state is needed for perfectly competitive markets?
Perfect information.
157
Can other factors of production experience immobility?
Yes, for example, capital immobility.
158
Are diesel cars associated with negative production externalities?
Yes.
159
What is the signalling function?
Changing prices help economic agents plan their consumption/production.
160
To whom does the incentive function apply?
Both consumers and producers.
161
What causes the price mechanism?
The rationing function of prices and the incentive function of prices.
162
What causes the allocative function of prices?
The price mechanism.
163
How can prices help achieve allocative efficiency?
By eliminating excess demand in one market and creating extra supply in those with a shortage.
164
What should you never forget when explaining the price mechanism?
Include details of the functions of prices.
165
What are two reasons markets don't achieve allocative efficiency?
1. Barriers to entry.
2. Market failure.
166
How does the price mechanism achieve productive efficiency?
Firms aim to minimise production costs to maximise profits.
167
Why is it important to specify relative prices?
Changes allow the price mechanism to take effect.
168
What is the most common market failure?
Imperfectly competitive markets.
169
What market failure occurs in a monopoly/cartel?
Partial market failure leading to allocative inefficiency.
170
When the functions of prices perform well, is there market failure?
Depends on the view of income inequality.
171
What is market failure?
Occurs where the price mechanism achieves an allocatively inefficient use of resources.
172
What are two properties of a private good?
1. Rival - consumption decreases quantity available to others.
2. Excludable - non-payers are excluded from benefits.
173
Why does non-rivalry create market failure?
Scarcity does not exist, collapsing the incentive function.
174
What are two properties of a public good?
1. Non-rivalry - consumption does not decrease quantity available.
2. Non-excludable - free-rider problem exists.
175
Why are lighthouses government run?
Because they are public goods.
176
What market failure do public goods experience?
Complete market failure.
177
Why is the military state provided?
It is a public good that is non-rival and non-excludable.
178
What is a public bad?
The opposite of a public good.
179
What is an example of a public bad?
Rubbish, which creates disutility if not managed.
180
What is an example of a place where public bads took over?
Cities in America charging for rubbish collection leading to fly-tipping.
181
What is a pure public good?
Something that is completely non-rival and non-excludable.
182
What are two types of public good?
1. Pure public good.
2. Quasi-public good.
183
What defines quasi-public goods?
Methods exist for excluding free riders.
184
What is an example of a quasi-public good?
Roads, where electronic pricing can exclude free riders.
185
What are two properties of a quasi-public good?
1. Semi-excludable.
2. Non-rivalrous.
186
Why do we need to charge for public goods in some instances?
Many are semi-rival.
187
Where are pure public goods best provided?
Outside of the market mechanism.
188
How does rivalry relate to pricing in public goods?
As roads become more used, rivalry becomes an issue, leading to road pricing.
189
What is an example of public goods obtaining a market as technology advances?
London congestion charge.
190
What is the link between externalities and public goods?
Externalities also have a missing market.
191
How can property rights negate externalities?
By marketising the world.
192
What market failure is associated with the free-rider problem?
Complete market failure.
193
Which function of prices breaks down the most when there is market failure?
Allocative function.
194
Why does the tragedy of the commons occur?
The marginal benefit is felt by one, while the marginal cost is divided among many.
195
What is an example that shows the Green Deal was a success?
It went through its budget in 6 weeks.
196
What was unique about the Green Deal?
Loss-avoidance bias led to popularity despite long-term costs.
197
Why was the Green Deal addressing market failure?
It targeted the negative externality of polluting fuels.
198
What is unique about a MSC/MPB graph for road use?
Non-rivalry means there is a threshold output point until the lines diverge.
199
Are MPC and MSC curves divergent or parallel?
Depends on the type of externality.
200
True or false: externalities are the only cause of allocative inefficiency.
No.
201
Is allocative efficiency achievable?
No, due to three conditions.
202
What are the three conditions that cause allocative efficiency to be rare?
1. Uncompetitive markets.
2. No economies of scale.
3. Markets not in equilibrium.
203
When is social equilibrium achieved?
When P=MSC.
204
Why does the market mechanism fail to account for externalities?
Economic agents only account for private costs/benefits.
205
Why do we issue subsidies to goods/services with negative externalities?
To achieve price competitiveness.
206
What is the difference in market failure between public goods and merit/demerit goods?
Public goods experience complete market failure.
207
What is meant by 'no economies of scale'?
It refers to a situation where increasing production does not lead to a decrease in per-unit costs.
208
When is social equilibrium achieved?
Social equilibrium is achieved when P = MSC.
209
Why do we issue subsidies to goods/services in competitive demand with negative externalities?
We cannot achieve price competitiveness when the price of the market failed good is low due to excluded social costs/benefits.
210
What is the difference in market failure between public goods and merit/demerit goods?
Public goods experience complete market failure, while merit/demerit goods experience partial market failure.
211
What are the 2 key features of a merit good?
1. Information failure in its consumption
2. Positive externalities in consumption
212
What is the most common cause of information failure in the consumption of merit/demerit goods?
Inter-temporal considerations.
213
Why are merit/demerit goods controversial?
Value judgements in the decision of externalities.
214
Information failures in merit goods/demerit goods are associated with what other phrase?
Internalities.
215
What are 3 examples of goods/services where it has not been decided whether it is a merit/demerit good?
1. Contraception
2. Abortion
3. Sterilisation
216
What is a staggering statistic about smokers?
On average, smokers die ten years earlier than non-smoking contemporaries.
217
What is moral hazard and adverse selection?
In private insurance markets, those with insurance act more dangerously (moral hazard), and adverse selection means that only those most likely to need insurance buy it.
218
Why is discrimination arguably less likely in the free market?
Many people acting collectively and with every incentive not to be discriminatory should reduce discrimination.
219
What effect does the signalling function have on the supply-side?
It incentivises entry from new firms.
220
Why is the price mechanism more allocatively efficient than a command economy?
The administrators needn't be paid.
221
What evidence shows that marketising a good can lead to market failure?
When we give a payment for marrow donations, donations fall.
222
Complete market failure is most likely for what type of goods?
Public goods.
223
Resource misallocation in market failure is another term for what?
Allocative inefficiency.
224
What is the formula for social benefit?
Social benefit = Private benefit + External benefit.
225
What is a quasi-public good and give an example?
A quasi-public good is when we modify a public good to make it rivalrous and/or excludable so it can be marketised, such as tollbooths on roads.
226
Why is it hard for the government to get the provision of public goods right?
Without the price mechanism, they must elucidate the socially optimum quantity.
227
What are 2 reasons public goods are not produced by the free market?
1. Consumers tend to undervalue and producers tend to overvalue the price.
2. Free rider problem.
228
Why should the MSB/MPB and MSC/MPC lines be divergent in most cases?
Whenever the externality scales with output, e.g., pollution, then divergent is more accurate.
229
How do you find the deadweight loss triangle?
Price when MPC=MPB, then draw a line to the other MSC/MSB curve at that price and that triangle is deadweight loss.
230
Why does Coase's theorem eradicate externalities?
The costs are not external; they are paid to someone.
231
What is the precise definition of the tragedy of the commons?
1. Rivalrous
2. Non-excludable
232
How could marketisation prevent the tragedy of the commons?
1. The owner is incentivised to look after the resource.
2. The revenue generated from charging polluters would cover costs and reduce these to acceptable levels.
233
What are 2 things property rights might be a solution to?
1. Externalities
2. Tragedy of the Commons.
234
What is an example of education's externality beyond economic?
2001 Moretti - less likely to be involved in crime.
235
For each 1% increase in education spending, what happens?
GDP growth increases by 0.15%.
236
Could education represent market failure?
Spence 1974 - signalling function - education used as a heuristic for quality, leading to labour market inefficiency.
237
What market failure always exists in the short run?
Factor mobility.
238
What is an example of immobility in the long run?
Labour hysteresis, e.g., firefighters won't train as bankers.
239
What is the term for the utility missed out on in an economy due to monopolies?
Welfare loss.
240
What did Michael Sandel discover about the price mechanism?
Sometimes the price mechanism discourages authentic behaviour because it discourages altruistic behaviour.
241
What are 2 occasions when monopolies should not be broken up?
1. When the size of the market is limited by economies of scale, it would be advantageous to have one firm.
2. Monopoly firms can be more dynamically efficient.
242
What are the 3 types of UK competition policy?
1. Monopoly policy
2. Merger policy
3. Restrictive trading practices policy.
243
What is the oldest type of competition policy?
Monopoly policy. The Monopolies Commission was set up in 1948.
244
What is the 3 step methodology for a CMA investigation?
1. Evidence of imperfect competition is detected.
2. Investigations continue using trade complaints.
3. Judge by reference to whether behaviour is competitive.
245
How does the CMA judge the behaviour of economic agents?
By reference to how their behaviour could distort competition, as stipulated in the 2002 Enterprise Act.
246
What is the CMA strategy?
Investigatory approach; the threat of a CMA investigation keeps businesses in line.
247
What are 6 alternative approaches we could take to monopoly?
1. Nationalise
2. Windfall taxes on profits
3. Privatise
4. Rate of Return regulation
5. Monopoly busting
6. Price controls.
248
What is the evaluation of windfall taxes?
Seldom used; the last major time was in 1997 by Gordon Brown.
249
Why does rate of return regulation not work?
It encourages firms to employ expensive capital.
250
Why does monopoly busting not work?
Some advantages of monopoly, e.g., dynamic efficiency.
251
Why are price controls not used?
Free market economists don't like them.
252
What is the rationale behind privatising monopolies?
It was argued that barriers are not so great as to protect monopoly firms, and discipline from shareholders would ensure that X-inefficiency was eliminated.
253
What are the 2 types of merger?
1. Merger - voluntary
2. Takeover - hostile takeover.
254
What is an SLC and how does the CMA use it to judge mergers?
SLC stands for Substantial Lessening of Competition; the CMA monitors merger activity in the economy.
255
What are 3 examples of independently undertaken restrictive practices the CMA can investigate?
1. Discriminatory prices
2. Refusal to stock a particular outlet
3. Full-line forcing.
256
How can the government resolve market failure in a relatively non-interventionist way?
By boosting information, e.g., through collaborative filtering, such as Ofsted - school league tables.
257
Where in the economy is deregulation particularly effective?
In small and medium enterprises (SMEs).
258
What are 3 reasons the CMA's power is limited?
1. Almost never break up monopolies.
2. Their methodology is nominally laissez-faire.
259
Why is the CMA not the only regulatory body in the market?
Some markets have their own individual regulators, such as Ofwat.
260
What mergers does the CMA investigate?
All those where the merger leads to a statutory monopoly (25%+ market share).
261
What is a statutory monopoly?
A monopoly with more than 25% market share.
262
What are 4 reasons competition is good?
1. Allocative efficiency - no income wasted on supernormal prices.
2. Non-price competition - better choice for consumers.
3. Productive efficiency - firms with X-inefficiency cannot survive.
4. Disruptive and sustaining innovation - easier for firms with innovative ideas to break through.
263
How did Labour justify post-war nationalisation?
"Commanding heights" of the economy should be in public ownership.
264
What is the benefit of nationalisation even if prices are not reduced?
No divorce of ownership from control - all profits can be reinvested.
265
What is a privatisation statistic?
Between 1981 and 2015, more than 16 major industries were privatised.
266
What are 3 arguments for privatisation and their evaluation?
1. Revenue raising - about 3-4 billion a year during privatisation's peak.
2. Reducing public spending on loss-making industries - government cannot go bankrupt.
3. Efficiency - research suggests UK nationalised industries were inefficient due to political rather than structural issues.
267
Why do free marketeers argue nationalised industries are inefficient?
They cite a special kind of X-inefficiency from laziness.
268
What are 3 reasons, politically, privatisation is popular?
1. Popular capitalism - people support it.
2. Revenue raising - sale of BT raised 3.9 billion for the Exchequer.
3. Political responsibility - politicians wanted to avoid being beholden to union bosses.
269
What are 3 arguments against privatisation?
1. Monopoly abuse.
2. Short-termism - underinvestment.
3. Undervaluation.
270
What is an example of private sector monopoly underinvestment?
In 2015, Thames Water's CEO received a 60% pay rise despite sewage issues.
271
What are the 2 types of regulation?
1. External regulation, usually by government.
2. Voluntary regulation.
272
Regulation by and large affects what?
The social costs of the free market.
273
What is the evaluation of regulation?
It can go too far and create X-inefficiency, reducing international competitiveness.
274
Why can regulation actually reduce welfare?
Sometimes it creates monopolies, e.g., airline regulation and British Airways.
275
How is contestable market theory linked to deregulation?
Deregulation makes markets more contestable, which can increase efficiency.
276
What is another reason deregulation might be beneficial?
It reduces the threat of regulatory capture.
277
Why do regulators sometimes behave overzealously?
They need to justify their own existence.
278
Are privatisation and deregulation compatible?
Some would say no; UK governments have privatised but also introduced regulators.
279
What are 2 ways to encourage merit good consumption?
1. Subsidies.
2. Regulation, e.g., vaccination and education.
280
What is an example of merit good regulation?
Education is compulsory from ages 5-18.
281
What is an example of a debate generated by merit good regulated provision?
What quality should education be?
282
What is an example of how regulation regarding positive externalities can go further?
Councils often force people to generate positive externalities, e.g., plant trees.
283
What is one adverse effect of taxes?
They can reduce competition due to extra costs.
284
Why might banning externalities not work?
Some industries need them, e.g., coal burning power stations.
285
What is a fact about taxes and negative externalities?
Taxes rather than regulation have become increasingly popular in recent years.
286
What is the problem with the 'polluter must pay' principle?
Many industries where the producer pollutes are highly price inelastic, shifting incidence to the consumer.
287
What is another reason taxes can be bad besides market concentration?
They create the possibility of government failure and inefficiency of the cost of collection.
288
What is an example of a tradeable permits scheme?
The ETS in the 1990s.
289
What are 2 reasons price ceilings and price floors are bad?
1. Allocative inefficiency: D ≠ S.
2. Government failure is likely; queues occur, with potential for corruption.
290
What do price controls do, factually?
They mess with the incentive function.
291
What is an example of a price ceiling causing problems?
NYC rent controls have been blamed for the decline in housing quality in Manhattan.
292
What is an example of how the Trumps used a shadow market to bypass NYC rent controls?
In 2018, the New York Times reported that the Trump family engaged in dubious accounting practices in the 1990s.
293
What are 3 reasons for government failure?
1. Pursuit of conflicting policy objectives.
2. Administrative costs.
3. Law of unintended consequences.
294
What is an example of the law of unintended consequences?
The landfill tax imposed in 1996 led to an increase in flytipping.
295
Where can market failure occur?
In a market economy or the market sector of a mixed economy.
296
What does a consumer judge the quality and scarcity of a product by?
By judging changes in the relative price, exploiting the signalling function of prices.
297
What is the signalling function?
Prices provide information to buyers and sellers.
298
What causes extensions in supply in line with the law of supply?
The incentive function of prices.
299
What is the incentive function of prices?
Prices create incentives for people to alter their economic behaviour.
300
Why is there a law of supply?
1. The incentive function of prices means firms believe they can make extra profit.
2. To cover increasing marginal costs.
301
What is responsible for the law of demand?
The rationing function of prices.
302
What is the allocative function of prices?
Changing relative prices allocate scarce resources away from markets exhibiting excess supply and into markets with excess demand.
303
Does the incentive function of prices just apply to suppliers?
No, a high price can encourage substitution.
304
How does the invisible hand of the market work?
1. Firms, driven by profit maximisation, cut costs and achieve productive efficiency.
2. Consumers buy from firms charging the lowest price, rewarding innovation.
3. Firms switch productive resources into markets that maximise their return.
305
How does the price mechanism promote consumer sovereignty?
The goods and services produced are those that consumers have 'voted' for when they bought them.
306
How is the price mechanism allegedly productively efficient?
Firms must cut costs to achieve profit maximisation; however, economies of scale and uncompetitive markets may hinder this.
307
What is the goal of firms in a competitive market?
Maximize profit, cut costs, and achieve productive efficiency.
308
How do consumers influence firms in a competitive market?
Consumers buy from firms charging the lowest price, rewarding innovation.
309
What do firms do with productive resources in a competitive market?
Switch productive resources into markets that maximize their return.
310
How does the price mechanism promote consumer sovereignty?
The goods and services produced are those that consumers have 'voted' for by purchasing them.
311
Why is the price mechanism considered productively efficient?
Firms must cut costs to achieve profit maximization.
312
What is a counterargument to the consumer sovereignty argument for the price mechanism?
Uncompetitive markets can lead to producer sovereignty, with a 'take it or leave it' approach.
313
What is consumer sovereignty?
When consumers have the most power in the market, deciding what is produced based on their purchasing behavior.
314
Why is the price mechanism better in competitive markets than uncompetitive markets?
Competitive markets promote consumer sovereignty, while uncompetitive markets lead to producer sovereignty.
315
Why do public goods experience complete market failure?
Because the price mechanism has broken down.
316
What is market failure?
Occurs when the price mechanism leads to a misallocation of resources that does not maximize economic welfare.
317
What is an external party in an externality called?
A 'third party'.
318
What is an example of excludability?
A shopkeeper can prevent people from consuming goods unless they are prepared to pay.
319
What is rivalry also known as?
Diminishability.
320
What is an example of rivalry?
If I eat a bar of chocolate, you can't benefit from it.
321
What does rivalry mean?
When I consume something, the quantity available to others diminishes.
322
What does excludable mean?
People who do not pay can be excluded from receiving the benefits of a good or service.
323
What is a private good?
A good that is both rival and excludable.
324
What is an example of a public good?
A lighthouse.
325
What are two reasons the lighthouse fails as a public good?
1. Rivalry - the light does not diminish for other ships. 2. Excludable - ships cannot be stopped from passing.
326
What problem is associated with public goods?
The 'free-rider' problem.
327
What mechanism of prices breaks down in public goods?
The incentive function - no longer profit making.
328
What is an example of how public goods are seldom provided by markets?
Trinity House provides lighthouses.
329
What are major examples of public goods beyond lighthouses?
Education, defense, street lighting, and police.
330
What do public bads consist of?
Externalities, as they are non-rival and non-excludable.
331
What do public bads lead to?
Loss of economic welfare and social welfare.
332
What are two examples of public bads?
1. Disease 2. Environmental threat to the global commons.
333
What is an example of an industry where public goods have not prevented production?
Vaccines, as firms can make sufficient profits selling to consumers.
334
What must arguments about market failure be qualified by?
The fact that they contain normative statements.
335
What happens when we try to charge for rubbish collection?
People simply pack their rubbish into smaller bags.
336
What happened in Seattle when rubbish pricing was introduced?
Collection fell by 37% in the first five months, but volume fell by only 14%.
337
What is the optimal level of public good consumption?
High, since non-rivalry allows for high levels of production.
338
How do we create quasi-public goods?
Make them more excludable, not more rival.
339
Why might the optimal level of public goods not be high?
There is always a capacity constraint.
340
What is an example of road pricing?
Road pricing was introduced in London in 2003.
341
What is the evaluation of road pricing?
1. Politically unpopular. 2. Loopholes being found.
342
Has there been a success to the London congestion charge?
Yes, slight traffic reduction observed.
343
Why is the optimal level of consumption for a public good achieved when price is zero?
Non-rivalry and non-excludability mean the marginal cost is effectively zero.
344
What occurs when externalities happen?
There is a divergence between private and social costs and benefits.
345
What is a property right?
The exclusive right to determine how a resource is used.
346
What is the free-rider problem?
Non-excludability leads to overconsumption and market failure.
347
What function of prices breaks down when externalities occur?
Primarily the allocative function in the case of production externalities.
348
What is an example of a positive consumption externality?
Co-consumption of the atmosphere.
349
Are externalities limited to concentrated/uncompetitive markets?
No.
350
What happens when negative production externalities occur?
The good/service is underpriced and overproduced.
351
What is the problem with property rights according to the Coase Theorem?
If a market can be created for property rights, pollution continues regardless of ownership.
352
What example did Coase use?
Wood-burning locomotives starting fires in crop fields.
353
What are the three types of ownership?
1. Private ownership 2. Government ownership 3. Common ownership.
354
Who theorized the Tragedy of the Commons and when?
Garrett Hardin in 1968.
355
Why did Hardin believe the optimal capacity of the common resource was always exceeded?
Marginal Utility exceeds Marginal Cost from overstressing the Commons.
356
What is an example illustrating the tragedy of the commons?
Grazing commonly owned farmland.
357
What real-life example did Hardin use?
A satellite photo of a North African field complex.
358
Who challenged Hardin and how?
Elinor Ostrom, showing that non-tragedy can occur under certain conditions.
359
What did Ostrom advocate?
Devolve control for better management of common resources. NOBEL PRIZE 2009
360
What evidence shows private property can combat the tragedy of the commons?
2015 - North Sea cod stock reached highest levels for 35 years.
361
What is an example of a market where the tragedy of the commons was solved?
Fisheries with Individual Transferable Quotas.
362
How can the tragedy of the commons be fixed?
By assigning property rights.
363
Why are subsidies sometimes limited in encouraging consumption of merit goods?
They do not capitalize on loss aversion bias.
364
What is an example of behavioral insights being more effective than subsidies?
Small rewards today rather than large rewards later.
365
What are three facts about the Green Deal?
1. Promotes environmentally friendly home improvements. 2. Spent £120 million budget in 6 weeks. 3. Uses current moment bias.
366
What are three problems with the Green Deal?
1. High APR on improvements. 2. Higher energy bills. 3. Varying quality of assessments.
367
What is an example of a huge environmental externality?
Smog in 1952.
368
In a shopping mall construction scenario, should it be built if private cost is £10 million and external cost is £20 million?
Yes, social cost is £30 million and social benefit is £33 million.
369
What must be divergent in the context of externalities?
The gradient of MSB/MPB and MSC/MPC curves.
370
What is deadweight loss to society?
The area where MPC > MSC or MPB > MSB.
371
What does the vertical distance between MSC and MPC curves show?
Marginal external cost (MEC).
372
What is road pricing used for?
Road congestion, not pollution.
373
What is an example of road pricing outside London?
M6 Toll.
374
Why is road pricing unlikely to be introduced?
Politics.
375
What is a quasi-public good example?
Roads, as tolls can be used to exclude free riders.
376
When is the congestion negative externality generated?
Only past a fixed level of output.
377
What type of externality is road congestion?
Both a consumption externality for consumers and production externalities for commercial vehicles.
378
When describing externalities and market failure, what terms should be used?
Use terms like 'thus an over/underconsumption/production occurs at Q..., because the firm is under/overpriced.'
379
When does allocative efficiency occur in the context of marginal costs?
When P = MC, or more specifically when P = MSC.
380
What is the main argument for rail subsidies?
To encourage substitute consumption by subsidizing rail fares due to overconsumption of private cars.
381
What is a key feature of an externality?
There is no market into which it can be bought and sold.
382
What is the link between public goods and public bads?
All externalities are a form of public goods/bads because their costs are felt by everyone.
383
What type of market failure do public goods experience?
Complete market failure, while merit/demerit goods experience partial market failure.
384
Are all goods with positive consumption externalities considered merit goods?
No, as some do not require government intervention.
385
When is the provision of merit goods seen as bad?
When it fails to address inequalities in ability to pay.
386
What occurs when demerit goods are consumed?
The social costs exceed the private costs incurred by the consumer.
387
What are two reasons the libertarian argument about consumption of demerit goods is flawed?
1. Impossible to let people consume as they wish without harming others. 2. Too narrow a view of freedom.
388
What is a key evaluation point in any market failure essay?
The view of libertarians as a normative statement and the primacy of freedom.
389
What is an example of a demerit good that was once considered a merit good?
Kensitas cigarettes marketed as a way to quash appetite.
390
What is an example of self-regulation?
Portman Group monitoring advertising.
391
What is an inter-temporal aspect of merit goods?
Preventative dentistry, where neglect leads to future issues.
392
What is a key way to combat merit good underconsumption?
Information campaigns and nudges.
393
What kind of information failure occurs in the consumption of merit and demerit goods?
Intertemporal information failure.
394
What bias underlines merit and demerit good consumption?
Current moment bias.
395
What is an example of a merit good with information failure?
Suncream, as people neglect its long-term benefits.
396
What problems do insurance schemes for merit goods have?
1. Moral hazard. 2. Adverse selection.
397
What is moral hazard?
The tendency to take greater risks when insured against consequences.
398
What are the two problems with insurance schemes?
1. Moral hazard - those insured are more likely to take risks. 2. Adverse selection - companies reject those most at risk.
399
Why is nationalisation a better option than insurance schemes?
Nationalisation would solve the adverse selection problem and would be easier to predict since the larger the population, the more predictable the behaviour.
400
What is moral hazard?
The tendency of individuals or firms to take greater risks when they are insured against the hypothetical consequences of those risks.
401
What are two examples of information failure that can create market failure?
1. Oligopoly price setting - information failure about what other firms will do creates price rings and outcomes which are not allocatively efficient. 2. Asymmetric information in second hand car markets - Akerlof's lemons - asymmetric information drives the price down since any car could be bad.
402
Why does monopoly provide an example of market failure?
Monopolists restrict output and raise prices, resulting in a deadweight loss since this is an allocatively inefficient outcome.
403
How is factor immobility linked to market failure? Provide two examples.
Factor immobility can create market failure. 1. Resources are squandered because people have to train twice. 2. Markets become less competitive, hence P ≠ MC, because firms are discouraged from entering markets due to the sunk costs involved.
404
Where is information failure induced market failure most likely?
Imperfectly competitive markets.
405
When is perfect competition more productively and allocatively efficient than imperfect competition?
When economies of scale do not exist.
406
How does monopoly create a net welfare loss?
A transfer of consumer surplus into producer surplus and monopoly profit.
407
What is competition policy?
The part of the government's microeconomic policy which aims to make markets more competitive.
408
When should monopoly not be disturbed? Provide two occasions.
1. Small market with economies of scale. 2. When advantages of innovation improve consumer welfare and increase competitiveness.
409
Why is monopoly policy a misleading name?
The CMA rarely deals explicitly with pure monopolies, more often with highly concentrated markets.
410
What is meant by a 'cost-benefit' approach to monopoly policy?
The CMA only challenges monopolies which directly demean the public interest, not those whose efficiency gains make them overall beneficial.
411
How did the 2002 Enterprise Act reform the regulatory system?
Changed the remit from 'public interest' to a specific list of competitive practices the authorities had to screen for.
412
What was there before the CMA?
The Office for Fair Trading and the Competition Commission, which originated with the Monopolies Commission in 1948.
413
What is a weakness of the way the CMA investigates?
Relatively few investigations are actually pursued, with the threat of investigation hopefully enough to keep companies in line.
414
What are four approaches competition policy could take?
1. The current CMA 'watchdog' approach. 2. 'Monopoly busting' - advocated by free marketeers. 3. Price controls. 4. Taxing monopoly profits.
415
What is an example of a monopoly profit tax?
Gordon Brown and the 1997 5 billion pound 'windfall levy' on privatised utility monopolies.
416
When interest rates are high, windfall taxes can be used on what?
Banks.
417
What do free marketeers believe happens in nationalised monopolies?
Insulated from competitive pressure, the working conditions become complacent and X-inefficiencies are created.
418
Why do free marketeers believe that privatised monopoly is better even in the absence of competitive pressure? Provide an evaluation.
Shareholders and capital markets will discipline the firms to act efficiently. However, this has just meant that investment has fallen.
419
How has merger policy evolved in recent years?
CMA self-refers cases, no longer relying on government notification.
420
What are two types of restrictive trading practices?
1. Independently undertaken restrictive practices. 2. Collective restrictive practices.
421
What are three examples of independently undertaken restrictive practices?
1. Price discrimination. 2. Refusal to supply a particular outlet. 3. Full-line forcing.
422
What is the most widespread example of collective restrictive trading practices?
Cartel/price ring.
423
When does the CMA not ban cartels?
When they are in the public interest, e.g., innovating.
424
What is an example of restrictive trading practices?
2018 - European Competition Commissioner fines Google 4.3 billion euros over restrictive trading practices.
425
What does monopoly lead to?
Manipulation of consumers and the exploitation of consumer sovereignty.
426
What is public ownership?
Ownership of firms, industries or assets by government.
427
What are two examples of 'temporary' nationalisation since 1979?
1. Northern Rock, Lloyds, RBS and HBOS after 2008. 2. East Coast Rail.
428
What is an example of nationalisation gone right?
2009-2015 - East Coast nationalised and run at a profit.
429
Why does privatisation frequently help get the structural deficit down?
Because many of the firms are loss making.
430
How can privatisation actually represent a net contribution to public finances in the long run? Provide an evaluation.
If the privatised company becomes profitable and hence pays corporation tax, but often bought by foreign companies.
431
What are two political reasons privatisation is good?
1. Popular capitalism is popular. 2. Get rid of the responsibility if things go wrong.
432
What is an example of how privatisation can outsource responsibility?
1997 Brown got a poll boost from windfall tax on utilities.
433
What are five arguments for privatisation?
1. Revenue raising. 2. Reducing public spending. 3. Promoting competition. 4. Promoting efficiency. 5. Popular capitalism.
434
How do free marketeers argue that privatisation will enable competition in markets, even those considered natural monopolies?
Recent reforms mean that the infrastructure is more publicly accessible.
435
What are four reasons to oppose privatisation?
1. Monopoly abuses now less regulated. 2. Short-termism wins over long-termism. 3. Selling to fund current spending. 4. Sold too cheaply.
436
What is a caveat to the anti-privatisation short-termism argument?
Public sector may also underinvest due to politics.
437
What is an example of internal regulation?
BMA.
438
What is an example of external regulation?
CMA.
439
What is regulation?
Imposition of rules and constraints on markets.
440
What is a key counter-evaluation of regulation?
Business cost.
441
What is an example of deregulation?
Removal of protected monopoly status for bus companies in the UK.
442
What are two things deregulation can do?
1. Make markets more contestable. 2. Make incumbents face lower costs.
443
What does contestable market theory justify?
Deregulation.
444
What do advocates of deregulation often say about regulators?
Risk of regulatory capture.
445
What is an example of regulation in the public interest?
Cigarette companies not allowed to put certain toxic ingredients in cigarettes.
446
What do free marketeers cite as a fundamental problem of regulatory agencies?
Must justify their own existence with ever greater regulation.
447
Is regulatory capture always deliberate corruption?
No, it can occur just through proximity.
448
What is evidence that the state now prefers state ownership rather than subsidies for merit goods?
2024 - VAT exemption on private schools abolished.
449
What could we do to make positive externalities more resilient?
Literally regulate to ensure it.
450
When is a quantity control (ban) inappropriate?
When externalities are generated in the production of a necessity.
451
Why were taxes unpopular until recently?
Taxes were seen as politically inviable.
452
What does taxation compensate for with negative externalities?
The missing market for the external cost.
453
When are taxes least efficient?
When PED is elastic.
454
When did the ETS come into existence?
1990s.
455
How can price floors create productive inefficiency?
Firms which are high on business costs are not evicted from the market.
456
What are six ways government can intervene to correct market failure?
1. Price controls. 2. Taxes and subsidies. 3. Nationalisation. 4. Regulation. 5. Trading schemes. 6. Property rights.
457
What is government failure?
When the government allocation of resources is more allocatively inefficient than the originally flawed free market one.
458
What is the main cause of government failure?
Information failure.
459
Why is government failure normative?
What is the social optimum quantity.
460
What is a key example of government failure being normative?
Has the government's tuition fee support created too many or too few graduates?
461
What is an example of pursuit of contradictory objectives as a cause of government failure?
HS2 cancellation - infrastructure development and deficit control.
462
Why can government failure occur even without anything done wrong?
Money spent on planning.
463
What is an example of a government intervention to boost investment?
November 2014 British Business Bank created to drive investment.
464
What is an example of a recent emergency nationalisation?
2025 - Scunthorpe Steel nationalisation.
465
What does a price floor correct besides misallocation of resources? HOW COULD WE ILLUSTRATE THIS ON A DIAGRAM?
Uncertainty and volatility in commodity markets leading to underinvestment.
It's essentially the positive production externality graph
466
What are two effects of price floors?
1. Solve market failure. 2. Protect producers from volatility.
467
Why are price floors bad for allocative efficiency?
Surpluses.
468
What is intervention buying?
Governments buy up excess supply in price floor markets.
469
What is the cost to governments of intervention buying after the imposition of a minimum price?
The surplus multiplied by the height on the y-axis.
470
What is a key evaluative comment for intervention buying?
Not affordable in developing countries.
471
What are three consumer evaluations of minimum prices?
1. Regressive. 2. Consumer surplus. 3. Must fund intervention buying.
472
When there are price floors with intervention buying, what happens to producer surplus?
Raises.
473
What is an evaluation with governments and minimum prices?
Opportunity costs on other markets.
474
When do governments use maximum prices?
To boost the affordability of necessity goods and services.
475
When are maximum prices least likely to reduce supply?
Immobile factors of production.
476
What happens to demand during a maximum price?
Extends.
477
What happens to supply during a maximum price?
Contracts.
478
What is market distortion?
Disequilibriums due to price controls.
479
Consumers benefit from a maximum price unless what?
If a shortage occurs then queues can be bad.
480
What is an example of a queue created by a maximum price and the problem?
Soviet Union set price controls - stable inflation but shortages and corruption.
481
Why can maximum prices worsen inequality?
Only some consumers can access.
482
Why do producers not like maximum prices?
Incentives disrupted and producer surplus reduced.
483
How could governments correct maximum price market failures? Provide an evaluation.
Subsidy, but opportunity cost of subsidy.
484
In the free market, with no externalities, at the equilibrium what is achieved?
Allocative efficiency.
485
When illustrating allocative efficiency in the market, what should you make sure to use?
MPC, MSC and MSB.
486
Why does MPC slope up?
Law of diminishing marginal returns -> increasing marginal cost.
487
Why does MPB slope downwards?
Individual consumer benefit from the last unit consumed.
488
What are three reasons MPB=MPC is allocatively efficient providing no externalities?
1. Maximisation of society surplus at D=S. 2. Maximisation of net social benefit because MSB=MSC. 3. Resources follow consumer demand.
489
Why is income inequality seen as a cause of market failure?
Inequitable.
490
What is a negative externality in production?
Costs to third parties as a result of the actions of producers.
491
How can negative externalities in production have an inter-temporal aspect?
If the depletion of a resource means less is available for future generations.
492
What is a negative externality in consumption?
Costs to third parties as a result of the actions of consumers.
493
For negative consumption externality, who is often the third party?
Government.
494
Why do consumers ignore social negative benefit in the consumption of goods with negative consumption externalities?
Self-interest - rational economic behaviour and utility maximisation.
495
What is an example of a key positive externality in production?
External economies e.g. training or R&D.
496
How are merit goods and demerit goods identified?
Via a normative judgement.
497
True or false - merit goods are underproduced?
Yes.
498
What lies at the heart of merit/demerit goods market failure?
Imperfect information leading to irrational behaviour.
499
Why is asymmetric information more probable than imperfect information in demerit good markets?
Many firms hide the full negative externalities.
500
What are two reasons for public good non-excludability?
1. No cost-efficient way to price. 2. Benefits not excludable.
501
What can stop a public good from becoming quasi-public?
Competition with another provider who has not made theirs rival and excludable, e.g., private beaches.
502
Why is there no private motivation to supply a public good?
Free rider problem - individuals have no incentive to contribute to the provision because they can wait for another to pay.
503
What is a missing market?
When no good or service is supplied, usually due to a public good market failure.
504
Example of a quasi-public good in roads?
Singapore electric road pricing.
505
What is a common access resource?
Natural resources over which no private ownership has been established.
506
Why is blanket regulation required for fixing the tragedy of the commons?
If only one firm stops, it won't be enough since other firms are still motivated to fill their place.
507
What diagram do you draw for a tragedy of the commons?
Negative externalities in production diagram, since marginal cost for firms is below social cost.
508
What are the 4 key sources of government failure?
1. Information failure, particularly when normative valuation of externalities is involved. 2. Regulatory capture. 3. Admin costs and enforcement, and opportunity cost of fiscal intervention. 4. Unintended consequences.
509
What is an unintended consequence of a subsidy?
Can reduce competitiveness of firms.
510
Example of modern black markets?
Smuggling of tobacco and alcohol to avoid excise duties.
511
What is an indirect tax?
A tax which increases a firm's cost of production, but can be shifted to consumers.
512
What are 4 evaluations for indirect taxes in the context of externalities?
1. Asymmetric information regarding setting tax. 2. Price inelastic demand. 3. Regressive. 4. Black markets risk.
513
What is a hypothecated tax?
Tax revenue is directed to a specific purpose, in the case of market failure could be for creating substitutes.
514
Why is the issue of price inelastic demand and tax effect significant for demerit good consumption?
1. Few substitutes. 2. Addictive. Likely inelastic PED.
515
Why is overtaxing worse than undertaxing?
1. Shut down firms. 2. More regressive. 3. More risk of black markets.
516
Why is the overuse of taxation a government policy conflict?
Indirect taxes are regressive, but tertiary government policy to reduce inequality.
517
Why are black markets bad?
1. Expensive to police. 2. Poor quality of traded goods.
518
What is a subsidy?
Money grant given to government to lower costs of production and encourage an increase in output.
519
What are 5 evaluations for the subsidy?
1. Cost. 2. Set at the wrong level. 3. Opportunity cost of subsidies (interest payments, cuts to public spending). 4. Price inelastic demand. 5. How will firms use the subsidy? What if they just incur higher costs?
520
How is regulation different from subsidies and taxes?
Regulation uses command and control approaches which are non-market based.
521
What makes regulation effective?
Effective enforcement.
522
What is a nice evaluation for regulation?
Some firms like it because it makes the market less competitive.
523
Does the UK have an ETS?
Yes, we inherited one from the EU.
524
What presumptions are made when we model an ETS in an exam?
1. Government knows optimum quantity of pollution and sets the cap here.
525
How does ETS work?
1. Firms have a choice - either invest in new technologies or buy more permits. 2. Allows time for each firm to consider factor mobility. 3. Each firm considers their opportunity cost as the supply of permits is reduced.
526
What are 2 benefits of ETS?
1. Incentivises investment which has its own positive effects. 2. Firms also generate the revenue to fund investment by selling permits at a higher price as supply of permits is reduced.
527
What are problems of ETS?
1. Easy to ignore, e.g., measuring pollution hard. 2. Imperfect info, e.g., EU set wrong. 3. Costs of production rises - if PED is inelastic they may shift incidence. 4. Globalisation allows firms to run away, risking structural unemployment. 5. There must be international cooperation.
528
Why is international agreement on ETS rare?
Developing countries say it is unfair they can't develop as the Global North did, and see ETS as a cost of business that will discourage MNCs.
529
What is state provision?
Direct provision of goods/services by the government free at the point of consumption.
530
What merit goods should be recommended for state provision?
Goods where not having state provision would be hugely inequitable.
531
Why is excess demand via state provision problematic?
1. Normative judgements have to be made for healthcare in lieu of rationing function. 2. For education, it is a lottery, with catchment areas and postcodes the determinant.
532
How can the private sector help with the excess demand in markets for state-provided resources?
Help soak up the excess demand for those who can afford.
533
Example of a minimum price?
Scottish alcohol price.
534
When is a minimum price good or bad for firms?
1. Good for firms if PED is inelastic since their revenue rises. 2. Bad for firms if PED is elastic since they lose revenue.
535
Example of how rent controls can cause firms to substitute production away from the rented market?
Real estate firms moving to build stuff like 432 Park Avenue.
536
Why will excess supply NOT occur for a minimum price when the good is a demerit good?
Intervention buying will not occur.
537
Why do maximum prices worsen inequality?
Some people will get the cheaper product at the price of the ceiling, and others will have to go on the black market and hence pay a higher price.
538
What is information provision?
Government funded information provision to encourage or discourage consumption.
539
What type of market failure is information provision very useful for?
Merit and demerit goods - information failure in markets.
540
What are 3 innate benefits of information provision?
1. Market aligned. 2. Doesn't suffer from paternalistic accusation. 3. Less of a risk of government failure.
541
How to illustrate information provision in merit/demerit goods?
Merit/demerit goods diagrams.
542
What are 3 problems of information campaigns as a way of fixing market failure?
1. Cost. 2. Long run changes in social norms - takes time. 3. No guarantee of success.
543
What is the problem with common access resources?
MPC always less than MSC.
544
How can property rights correct common access resources market failures?
1. MSC fully internalised, including inter-temporal aspects. 2. Negative externalities are internalised. 3. If enforced, MSB=MSC.
545
What are 3 problems with property rights?
1. Some resources, e.g., air, are very hard to effectively assign property rights to. 2. Enforcement costs. 3. Equity - who gets the rights?
546
What can make property rights for common access resources more successful?
International collaboration, e.g., EU Fishing Quotas.
547
What are the motives in a market economy vs command economy?
Profit maximization vs max welfare.
548
What is the freedom of choice in market economy vs command economy?
Higher in market vs lower in command.
549
What is the level of competition in market economy vs command economy?
Higher in market vs lower in command.
550
What is the role of government in market economy vs command economy?
Higher in market vs lower in command.
551
Generally speaking, goods and services are ___ in command economies?
Lower quality and product differentiation is almost unheard of.
552
What is PES in market vs command economy?
More elastic in market vs inelastic in command.
553
Why is there an efficiency trade off in market economies versus command economies?
Allocative more in command (government failure) vs productive more in market.
554
What are shortages and surpluses in market vs command economy?
Shouldn't happen in market vs likely in command.
555
What are merit/demerit goods in market vs command economies?
Command economies do better here.
556
What are public goods in market vs command economy?
More likely to be provided in command economy.
557
What is income distribution in market vs command economy?
More unequal in market.
558
What are negative externalities in market vs command economy?
Rampant in market vs extinct in command.
559
What are monopolies in market vs command economy?
No market monopolies in command vs can exist in market.
560
Are there any pure real world market or command economies?
No, but approximations occur.
561
What are 3 explanations of how allocative efficiency is achieved in free markets?
1. Consumer demand is perfectly met by supply. 2. Total social welfare is maximised. 3. Net social benefit is maximised.
562
What are 6 benefits of a free market?
1. Allocative efficiency. 2. Competition higher. 3. Dynamic efficiency/investment. 4. Job creation/growth. 5. Freedom, liberty and choice. 6. No risk of government failure.
563
What are 5 arguments against free markets?
1. Markets can fail. 2. Inequity due to inequality. 3. Uncompetitive markets. 4. Creative destruction. 5. Price volatility.
564
What does EPIC stand for?
Efficiency, Productivity, Incentives, Competition.
565
Why is creative destruction a key concern of the free market?
Regionally concentrated structural unemployment.
566
What is specialisation?
The concentration of production on a narrow range of goods or services.
567
What do prices in primary commodity markets tend to do?
Swing wildly.
568
What are 2 reasons PED for primary commodities is inelastic?
1. Necessities. 2. Lack of good substitutes.
569
Why is PES of commodities inelastic?
1. Large production lags. 2. Hard to store - price takers.
570
What are commodity markets particularly vulnerable to?
Demand and supply-side shocks.
571
Why are commodities often experiencing market failure?
Long-run people often leave due to volatility.
572
Why are recessions in developing countries often more volatile? AND ANOTHER THING - WHAT IS CO-CONSUMPTION?
Export revenues fluctuate because commodity prices change.
WHEN CONSUMPTION GENERATES A POSITIVE EXTERNALITY BECAUSE IT GENERATES NON-EXCLUDABLE BENEFITS E.G. A VACCINE AND HERD IMMUNITY OR THE ATMOSPHERE AT A FOOTBALL GAME
