Market Failure Flashcards
What is the definition of negative externality?
It is the spillover costs to third parties who are not directly involved in the production or consumption of the good, and no compensation is made
How does negative externality lead to market failure?
F: In free market, consumers/producers c/p at Qf where MPB=MPC to max. net private benefit (where MPB is _ & MPC is _)
A: -
D: c/p do not consider the MEC of third parties such as _ where (cost), this leads to a divergence of MPC and MSC where MSC>MPC at all levels of c/p
S: societal market eq is at Qs where MSC=MSB
O: there is an over-consumption/production of QsQf
D: there is a deadweight loss on society shown by the shaded area
GG: Gov goal of allocative efficiency is not achieved
What is the definition of positive externality?
It is the spillover benefits to third parties who are not directly involved in the production or consumption of a good
How does positive externality lead to market failure?
F: In free market, consumers/producers c/p at Qf where MPB=MPC to max. net private benefit (where MPB is _ and MPC is _)
A: -
D: c/p do not consider the MEB on third parties such as _ where (benefit) , this leads to a divergence of MSB and MPB where MSB>MPB at all levels of c/p
S: Societal efficient eq is at Qs where MSB=MSC
U: there is an under-consumption/production of amount of QsQf
D: dead weight loss on society arises and is represented by the shaded area
GG: Gov goal of allocative efficiency is not achieved
What is the definition of merit goods?
Goods that are desirable and under consumed
How does imperfect information for merit goods leads to market failure?
F: Example of MPBpercieved hence consumers only consume at MPBpercieved=MPC to max private benefit
A-
D: Being myopic, they do not see the long term benefit of consuming more___, there is a divergence of MPBperceived and MPBactual
S: Societally efficient eq is at Qs where MSC=MPC=MPBactual
U:underconsumption of amt QsQf
D: deadweight loss on society shown by shaded area
GG:
How does subsidies solve market failure?
1) Subsidy given = to MEB
2) MPC decreases to MPC= MPC+subsidy
3) MEB is internalised by c/p
4) DWL is removed as c/p increases till Qs at MPC=MPB
What are the pros and cons of subsidies?
Pros:
Appropriateness-addresses root cause of positive ext
Cons:
Effectiveness: only effective when know exact amount of subsidy to provide
Appropriateness- does not address imperfect info
Side effects: Worsen fiscal health
How does free(direct) provision solve market failure?
1) MPC=0
2) Consumers will consume till MPB=MPC=0
3) DWL eliminated
What are the pros and cons of free provision?
Pros:
Feasibility- easier to implement
Effectiveness- effective if Qs is at a vey high level
Cons:
Feasibility- May be costly
Effectiveness- if MEB not large enough, can lead to overconsumption
How does joint provision solve market failure?
1) Private sector provides till Qf
2) Government provides amount QsQf, thus removing DWL
What are the pros and cons of joint provision?
Pros:
Feasibility- cheaper to implement than direct provision (don’t need to provide subsidies for everyone)
Cons:
Effectiveness- Gov may not know exact amount of QsQf, may lead to inefficient allocation of resources
Appropriate- mitigates problem but does not address root cause of +ve externalities
How does legislation/laws & regulations solve market failure?
1) Forces consumer/producer to c/p at Qs, DWL is removed
2) Fines are normally used as penalties
What are the pros and cons for legislation/laws & regulation for positive externality?
Pros:
Time-works quickly due to heavy penalties
Cons:
Feasibility- administration costs may be costly to monitor and enforce
Appropriate- does not address imperfect info
How does public education solve market failure?
1) Government attempts to close information gap between MPBactual and MPBpercieved by campaigns and advertisements
2) c/p at Qs, DWL eliminated
