8 Market failure and govt intervention in markets

Question 1

Functions of prices

Answer 1

1. Rationing function
2. Signalling function
3. Incentive function
4. Allocative function

Question 2

Rationing function

Answer 2

increasing prices rations demand to those most able to afford a good/service

Question 3

Signalling function

Answer 3

prices provide important info to market participants

Question 4

Incentive function

Answer 4

prices create incentives for market participants to change their actions

Question 5

Allocative function

Answer 5

the function of prices that acts to divert resources to where returns can be maximised

Question 6

Market failure

Answer 6

when the free market leads to a misallocation of resources in an economy

Question 7

Complete market failure

Answer 7

when the market fails - missing market

Question 8

Two characteristics for public good

Answer 8

• non-excludable
• non-rival

Question 9

The free-rider problem

Answer 9

when the consumers hope to get ‘free ride’ without paying for a good

Question 10

Quasi-public good

Answer 10

a good that is either non-excludable or non-rival

Question 11

Externalities

Answer 11

a knock-on effect of an economic transaction upon third parties

Question 12

Positive externalities in production

Answer 12

MSC is bigger than MPC/ underproduction

Question 13

Positive externalities in consumption

Answer 13

MSB is bigger than MPB/ underconsumption ; MERIT GOOD

Question 14

Negative externalities in production

Answer 14

MPC is bigger than MSC/ overproduction

Question 15

Negative externalities in consumption

Answer 15

MPB is bigger than MSB/ overconsumption ; DEMERIT GOOD

Question 16

Environmental market failure

Answer 16

negative externalities arising from the over exploitation of environmental resources

Question 17

The tragedy of commons

Answer 17

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

Question 18

Equity

Answer 18

the notion of fairness in society

Question 19

Reasons for government to intervene into the market

Answer 19

• correct market failure
• achieve a fairer distribution of wealth and income
• achieve the government’s macroeconomic objectives for the economy

Question 20

Two types of indirect taxes

Answer 20

• unit tax
• ad valorem tax

Question 21

Subsidy

Answer 21

a payment made to producers to encourage increased production of a good/service

Question 22

Minimum price

Answer 22

a price floor placed above the free market equilibrium price

Question 23

Maximum price

Answer 23

a price ceiling above which prices are not permitted to rise

Question 24

Regulation

Answer 24

rules or laws used to control or restrict the actions of economic agents in order to reduce market failure
example: banning smoking in public places

Question 25

Pollution permits

Answer 25

the right use or exploit an economic resource to a specific degree

Question 26

Competition policy

Answer 26

it involves measures to enhance competition between firms in order to improve economic outcomes for society

Question 27

Merger

Answer 27

when two or more companies willingly Jon together

Question 28

Public ownership

Answer 28

government ownership of firms industries or other assets

Question 29

Privatisation

Answer 29

the sale of government-owned assets to the private sector

Question 30

Government failure

Answer 30

when government intervention in a market reduces overall economic welfare

Question 31

Reasons for government failure

Answer 31

- inadequate info - unintended consequences - market distortions - administrative costs - regulatory capture