market failure Flashcards
(12 cards)
market failure definition
when the free market fails to achieve allocative efficiency
negative externalities definition
costs borne by 3rd parties who are not involved in the production or consumption of the good and they are not compensated for it
existence of MEC, how it leads to the divergence
due to the presence of negative externalities, it leads to the divergence between the marginal private cost and the marginal social costs as ＭSC= MPC+MEC and MEC>0
how market equilibrum level and socially optimal level is obtained
-assuming that there are no positive externalities, MSB=MPB
when left to the free market, producers pursuing their self-interest of profit maximisation takes into account only their private costs and benefit, ignoring external costs.
- to achieve profit maximisation, the firms will produce at the level Qp where MPB=MSB
welfare loss
since Qp is greater than Qs, cannot achieve an optimal allocation of resources.
there is an overproduction of resources
-social cost of an additional unit produced is higher than the social benefit, resulting in deadweight loss
indirect tax
-indirect tax can be levied to correct market failure
-government can impose an indirect tax of the amount equal to marginal external cost (MEC) at social optimal output Qs.
-forces firms to internalise the external cost and increases the cost of production
-increase marginal private cost (MPC) and MPC curve will shift to the left to MPC1 which will coincide with marginal social cost (MPC)
benefits of taxation
-generate additional tax revenue which can be used by the government, can use to fund research
-can be easily adjusted up or down
-provides incentives for the firms to reduce external costs, engaging research and monitor to reduce tax burden
-more effective than subsidies to change consumer’s behaviour due to loss aversion
limitations of taxation
-government may find it difficult to estimate the exact amount of tax to impose
-external costs are difficult to define in monetary terms due to tangible and intangible costs
rules and regulations
-controlling business activities through laws and administrative rules
- can pass legislation to prohibit or regulate consumption or production of activities that generates external costs
benefits of rules and regulations
- quick and effective to reduce overall level of production or consumption
limitations of rules and regulations
-high administrative cost of monitoring compliance and enforcement
-opportunity cost of government
-blunt measure
public education
-government may attempt to change the taste and preference of consumers by raising awareness of the external cost of certain goods that they consume
-when they recognize the effect it has on others, it could cause consumers to be less willing to consume to good
-MPB to fall and MPB curve will shift towards MPB’
- equilibrium quantity to fall from Qp to Qs
