Chapter 2.10 Market failure

Question 1

When does market failure occur (broadly)

Answer 1

When market forces fail to produce the products that consumers demand in the right quantities and at the lowest possible cost - inefficiency

Question 2

What are the types of market failure?

Answer 2

• failure to take into account
  all costs and benefits
• information failure

-Merit goods

-Demerit goods

-Public and private goods

-Abuse of monopoly power

-immobility of resources

-short termism

Question 3

What does failure to take into account all costs refer to?

Answer 3

Market failure occurring because the firm only considers their private costs, they ignore the external costs.

This means the external costs are not paid for by anyone.

If the FULL cost (social costs) had to be paid, firms would produce much less

Question 4

What are private costs?

Answer 4

costs borne by those directly consuming or producing a product

Question 5

What are external costs? examples?

Answer 5

Costs imposed on those who are not involved (third parties) in the consumption and production activities of others directly.

e.g Air pollution from factories
Industrial waste in rivers

Question 6

define third parties

Answer 6

Those not directly involved in producing or consuming a product

Question 7

Define social benefits

Answer 7

the total benefits to a society of an economic activity

Question 8

Define private benefits

Answer 8

Benefits received by those directly consuming or producing a product.

Question 9

What is usually imposed on third parties

Answer 9

significant external costs

Question 10

What is the total cost to society from production of a good?

Answer 10

the private costs + external costs

Question 11

The firm produces ________ because they only think about their private costs

Answer 11

more

Question 12

The firm produces more because they only think about their __________

Answer 12

private costs

Question 13

Firms should produce _______ because they should consider the external costs too.

Answer 13

less

Question 14

Firms should produce less because they should consider the _________ too.

Answer 14

external costs

Question 15

What does failure to take into account the external cost of a good lead to

Answer 15

the inefficient overallocation of this good

Question 16

What does the failure to account all benefits refer to?

Answer 16

Individuals only

Question 17

Define external benefits and give examples

Answer 17

benefits enjoyed by those who are not involved in the consumption and production activities of other directly

e.g:

Education → A well-educated workforce leads to higher productivity and economic growth, benefiting society.

Public transport → Reduces traffic congestion and pollution, benefiting all road users.

Question 18

What is socially optimum output?

Answer 18

The level of output where social cost equals social benefit and society’s welfare is maximised

Question 19

How is full social benefit represented on a graph?

Answer 19

Original demand curve- private benefit

The demand curve shifted right- full social benefit

Price moves up and is labelled pso (socially optimum

Original price is labelled pfm (free market)

same with Qfm

supply extends due to increased price

Question 20

How is full social benefit represented on a graph?

Answer 20

Original demand curve- private benefit

The demand curve shifted right- full social benefit

Price moves up and is labelled pso (socially optimum

Original price is labelled pfm (free market)

same with Qfm

supply extends due to increased price

Question 21

How is full social cost represented on a graph?

Answer 21

Supply is shifted to the left (full cost)

Original supply (private cost)

Price is increased if S is shifted to the left (labelled Pso)

Og price is labelled pfm

Quantity is decreased to Qso

og quantity is labelled Qfm

Question 22

The consumer consumes ________ because they only think about their private benefit

Answer 22

less

Question 23

The consumer consumes less because they only consider their _________

Answer 23

private benefit

Question 24

They SHOULD consume __________ because they should consider the external benefit too

Answer 24

more

Question 25

They SHOULD consume more because they should consider the __________ too

Answer 25

external benefit

Question 26

What does failure to take into account external benefits lead to?

Answer 26

inefficient underallocation of this good

Question 27

Define and explain demerit goods

Answer 27

Goods that are harmful to the consumer and/or wider society. People don't know, underestimate or ignore the harm it causes to themselves and society These goods generate external costs and will be over-consumed and over-produced if left to market forces. e.g cigarettes, junk food, drugs

Question 28

Whats an example of a demerit good having an external cost?

Answer 28

Smoking cigarettes not only harms the smoker’s health (private cost) but also imposes external costs on third parties: Secondhand smoke affecting non-smokers Healthcare costs burdening taxpayers and public health systems. Littering from cigarette butts

Question 29

Define and explain merit goods

Answer 29

These are goods that are beneficial to the consumer and/or wider society People don't know, underestimate or ignore the good it brings to themselves and society Consumers tend to UNDERCONSUME these goods e.g contraception, education, healthcare

Question 30

What is an example of a merit good being underconsumed?

Answer 30

People may underconsume vaccines because they ignore the external benefits If too many people avoid vaccination, diseases can spread, causing higher healthcare costs and outbreaks.

Question 31

How does lack of information lead to market failure?

Answer 31

consumers need to be fully informed about a good or service to make right decisions in a market where the producer/seller is an 'expert' and a consumer is not familiar, the consumer might be encouraged to buy or pay too much for a product e.g car mechanics services, technology, insurance

Question 32

Why might information failure be a problem in labour markets?

Answer 32

An employer may lack information about struggles an employee may face in their jobs an employee may lack info about the job itself. This can lead to misallocation of labour and contributes to underemployment, job dissatisfaction, and productivity losses

Question 33

What are public goods?

Answer 33

A public good is a product which is non-rival and non- excludable and hence is not provided in a free market economy e.g national defence, police services, infrastructure

Question 34

Why does the free market fail to provide public goods?

Answer 34

The free rider problem and the lack of profit incentive for firms: Since firms cannot make money from public goods, they won’t produce them, leading to market failure- a lack of a market in this case.

Question 35

What does non-excludable mean?

Answer 35

A good is non-excludable if people cannot be prevented from using it, even if they don’t pay. Example: Street lighting → Once installed, everyone benefits, even those who don’t contribute.

Question 36

What is the free rider problem?

Answer 36

The free rider problem occurs when people benefit from a good or service without paying for it and so nobody is willing to buy it, leading to no production in a free market.

Question 37

What does non-rivalry mean

Answer 37

A good is non-rivalrous if one person’s use does not reduce its availability for others. Example: Street lighting → One person using it doesn’t stop others from benefiting.

Question 38

How does immobility of resources lead to market failure

Answer 38

If resources, especially labour, are geographically or occupationally immobile, markets may not be able to move resources to their most efficient use.

Question 39

Whats an example of immobility of resources?

Answer 39

-lack of skills (occupational immobility) -High house prices- (geographical immobility) -Poor transport

Question 40

What is a monopoly?

Answer 40

A monopoly is a market structure where a single firm dominates the industry, with no close substitutes and high barriers to entry.

Question 41

How do monopolies cause market failure?

Answer 41

Monopolies lead to consumers having no choice but to buy from that firm. The firm therefore lacks the competitive pressures to keep costs and prices low and quality high. Monopolies tend to be inefficient and exploit consumers with high prices

Question 42

What is an example of a monopoly power exploiting consumers?

Answer 42

A local water supplier with no competition may increase prices for water as consumers have no alternative.