Market Failure Flashcards
Define the social optimum output
Social optimum output refers to the level of output where society’s welfare is maximised.
Define Market failure
Market failure is an economic situation in which the free market fails to allocate resources efficiently towards the production/ consumption of the combination of goods and services, which maximises society’s welfare.
Define marginal social benefit
It is the gain in welfare by the whole society when an additional unit of good is produced or consumed.
Define Non-rivalry
When a good is non-rivalry, the consumption of the good will not diminish the quantity and/or quality available to other consumers.
Define marginal social cost
It is the cost incurred by the society when an additional unit of a good is produced or consumed.
Define Non-excludability
A good is non-excludable when the good/service cannot be limited to the consumers who have paid for it. It is very difficult or costly to exclude anyone from enjoying the benefit of a good once it is made available even if he/she refuses to pay for it.
What are the characteristics of public goods?
They are non-rivalry and non-excludable, and they are provided by the government. They have no effective demand and supply and so there is total market failure (no revenue can be gained)
What are the factors of consideration for the government when providing public goods?
They have to consider the opportunity cost, they have to decide the amount to produce and may be subjected to information failure, it may not be feasible for some countries due to financial constraint.
Define positive externality
Positive externalities can be defined as third-party benefits resulting from the consumption/ production of a good/service
What are the government’s factors of consideration when granting subsidies? (1 pro and 1 con) (Points for essay)
Due to imperfect information it may not be easy to accurately estimate the value of MEB.
An over-valuation of the MEB implies that although output is increased, it will result in over-
consumption or over-production and welfare is again not maximised and may result in an even bigger dead weight loss.
It is a market-based solution such that the market can continue to play a role in resource allocation.
What is an externality?
An externality is an uncompensated spillover/ third-party effect arising from the consumption or production of a good/ service.
What is the purpose of subsidies?
Subsidies aim to encourage consumption up to the socially optimum level of output.
What are the policies implemented to target imperfect information?
Provision of information through public education
What are the government’s factors of consideration when tackling imperfect information with public education?
It directly addresses one root cause of the problem, there is a presence of cognitive bias as consumers tastes and preferences will be changed as they will have a clearer picture when consuming.
Recall essay points and steps for subsidies on positive externalities.
By providing a per-unit subsidy that is equal to the MEB at 0Qs. The subsidy provides the same effect as decreasing the marginal private cost of production/ consumption and forces individuals/ firms to take into account the positive externality. Thus, the subsidy shifts MPC vertically downwards to MPC – subsidy curve. The new private optimal output level where MPC’=MPB is now at 0QP’. This means that producers or consumers will now increase production or consumption to the socially optimal level 0QS. Leading to efficient allocation of resources removal of deadweight loss as society’s welfare is maximised. Thus, allocative efficiency is attained with the removal of the welfare loss.
