Market failure Flashcards
What is market failure?
When the price mechanism leads to a misallocation of scarce resources causing a loss in social welfare
Define externalities
The cost or benefit a third party receives from the economic transaction of a good or service outside of the price mechanism. It is a spill over effect leading to under or over production of goods meaning resources have not been allocated efficiently
Define public goods
Goods that are non-rivalry and non-excludable therefore underprovided by the private sector due to the free-rider problem. The market is unable to ensure enough of these goods are provided
What is the socially optimum position in a negative production externalities diagram?
Where MSB = MSC
Why is it difficult to work out the size of an externality?
It tends to be placed on valued judgements since it is difficult to monetise external costs
Explain the relationship between externalities and information gaps
As people lack information, they are unaware with the full implications of their descions
Explain the relationship between externalities and information gaps
As people lack information, they are unaware with the full implications of their descions
Define quasi-public goods
Goods that aren’t perfectly non-excludable and non-rivalry. Semi instead
An example would be roads
Define symmetric and asymmetric information
Symmetric - When buyers and sellers have potential asceses to the same information
Asymmetric - When one party has superior knowledge compared to another, that superior party can take advantage of the other party’s lack of knowledge
How does advertising lead to information gaps?
Adverts are designed to change the attitudes of a consumer to encourage them to buy the good, causing them to think the benefits of the goods are greater than they actually are.
How does information gaps lead to market failure?
There is a misallocation of goods as consumers are not making decisions that maximise their welfare, it means consumer demand for a good or producer supply of a good it too high or too low, thus price and quantity are not operating at the socially optimum position.
Give some examples of information gaps
Drugs - consumers do not know the long-term effects
Pensions - young people do not know the long-term benefits of paying into their pension schemes
Financial services - suppliers have more info than consumers, moral hazard
Define the principle-agent problem
Give an example
When the goals of the principle (the person who gains/loses from the decision) are different from the agents (those making the decision of behalf of the principle)
e.g. education child = principle agents = gov/parents - child has imperfect information as they don’t know the benefits of education therefore devote few resources to it, if allowed.
Define free market economy
Resources are allocated by the price mechanism, no government intervention
