LS17 - Market Failures Flashcards
(16 cards)
Market Failure
Where too little or too much of a good is produced or consumed compared to the socially optimum level of output
OR
When the price mechanism leads to an inefficient allocation of resources
The three types of market failure
- Externality
- The under-provision of public goods
- Information gaps
What is an Externality
The cost or benefit a third party who is not involved in the transaction receives.
Positive Externality
This is where there are external benefits from the transaction to the third parties.
Private costs and Social costs
A private cost is the cost to the economic agents involved in the transaction
A social cost is the cost to society as a whole and contains the private costs
MSC - Marginal social cost
MPC - Marginal private cost
Private benefit and Social benefit
Private benefit is the benefit derived from the consumption of a good to those consuming it.
Social benefit is the private benefit + the social benefit
Social Optimum
- What it shows
- Where on a graph it would be
Where the social cost of producing is the same as the social benefit of consuming the good
It is at where MSC=MSB
Negative Externality
A negative externality is where there are external costs to third parties in an economic transaction
The way of remembering how to draw negative and how to draw positive externality
Axis - Y=Cost & Benefit (£)
X= Output (quantity)
Negative externality. Two supply one demand. MSC on top
Positive externality. Two demand one supply MSB on top
Welfare loss and Welfare gain
Welfare loss is when the costs are greater than the benefits and is within a negative externality diagram
Welfare gain is when the benefits are greater than the costs in a positive externality diagram
How the government can limit the negative externality and why is a negative externality a problem
It is a problem because there is a cost to the third party who are not involved in the transaction.
- Indirect taxes. Makes the price of demerit goods more expensive, reducing consumption
- Subsidies. Encourage production of merit goods to decrease social cost
- Regulation. Limit the consumption of demerit goods
- Provide Information. Educate people so they can make informed economic decisions
Public goods
These are goods which are non-excludable and non-rivalrous
Non Excludable
This means that consuming the good doesn’t stop someone else from doing so
Non Rivalrous
This means that benefit one person gets for consuming the good wont affect the benefit someone else will get from consuming the good
The free rider problem
This is where public goods give people who aren’t paying for the good benefits and therefore they wont pay for the good
Why are public goods under provided in the market
- The free rider problem, people are receiving the benefits for a good even when they aren’t paying for the good
- Its hard to put a value on the price of a good and therefore consumers are likely to undervalue the good.
