Chapter 5: Market failure and negative externalities Flashcards Preview

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Flashcards in Chapter 5: Market failure and negative externalities Deck (60)
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What is market failure?

When market forces fail to deliver the best level of output for society, which leads to a loss of welfare.


When is market failure said to exist?

When the price mechanism fails to deliver the optimal and most efficient allocation of resources such that the best level of output for society is reached.


What is the price mechanism?

The demand and supply model.


How can a government intervene to try and correct market failure?

Information, taxing, subsidising or legislating.


What might happen as a result of government intervention?

The outcome may be a deepening of the market failure, a new failure may arise or the intervention strategy is just ineffective.


When does government failure exist?

When government intervention leads to a less efficient allocation of resources.


What is public choice theory?

It assumes that individuals seek to maximise satisfaction and firms seek to maximise profits.


Why do economists question whether politicians' motives are consistent with the pursuit of policies to correct market failure?

Politicians attempt to maximise their own self-interest through maximising votes.


What are negative externalities/external costs?

They are the third-party or spill-over effects arising from the production and/or consumption of goods and services.


When do negative externalities exist?

When the social costs of an economic action are greater than the private costs.


What is the formula for social costs?

Private costs + external costs = social costs


What needs to happen in order for the optimal level of production to occur where all costs and benefits are taken into account?

The market should produce at the output and price level where the marginal social cost is equal to the marginal social benefit.


What is a demerit good?

A good that is valued more by the individual than society so the marginal private benefits are higher than the marginal social benefits.


Give an example of negative externalities from consumption.

The consumption of too much alcohol may impose spill-over costs on society such as drink-driving, violence, days off work and domestic abuse.


What are the axis labelled on an externalities graph?

Costs and benefits are along the y axis and quantity is on the x axis.


What are the demand curves on an externalities graph labelled?

Marginal social benefit and marginal private benefit.


What are the supply curves on an externalities graph labelled?

Marginal social cost and marginal private cost.


Which area on a graph for a demerit good represents the net welfare loss?

It is a triangle. Its largest side is the distance between the benefits curves.


What does the MPB curve represent on a graph for a demerit good?

An individual's satisfaction from the consumption of the demerit good.


When can a complete ban be justified?

When the social marginal cost of consumption is always higher than the social marginal benefit i.e. the two curves do not intersect.


What does the combined area of consumer and producer surplus indicate?

The welfare from the production and consumption of a product.


What happens in the region of consumer and producer surplus?

The marginal benefit is higher than the marginal cost.


What would happen if the producer of a product were to take into account all the external costs and what represents this?

Their costs of production would be higher and this is represented by the marginal social cost curve.


What does the vertical distance between the two supply curves that reflect costs show?

The size of the negative externality.


What is a net welfare loss?

An area of negative welfare for society.


What area is net welfare loss represented by on a diagram where the marginal social cost is higher than the marginal private cost?

It is a triangle and its largest side is the distance between the marginal social cost and the marginal social benefit.


What is the market failure with demerit goods?

The free market will overproduce demerit goods.


What is the point of government intervention when negative externalities exist?

The government tries to make firms internalise their costs.


How are taxes a method of government intervention?

If the government were to introduce a tax equal to the negative externality then this would shift the firm's marginal private cost curve to the left.


What are the results of imposing a tax onto a product?

There is a fall in the production and consumption of the product but also there is a reduction in the size of the net welfare loss.