market failure

Question 1

rationing function

Answer 1

Rationing function: increasing prices rations demand to those most able to afford a good or service.

Question 2

signalling function

Answer 2

Signalling function: prices provide important information to market participants.

Question 3

incentive function

Answer 3

Incentive function: prices create incentives for market participants to change their actions.

Question 4

market failure

Answer 4

Market failure: when the free market leads to a misallocation of resources in an economy.

Question 5

Complete market failure

Answer 5

Complete market failure: when the free market fails to create a market for a good or service, also referred to as a missing market.

Question 6

partial market failure

Answer 6

Partial market failure: when a market for a good or service exists, but it is consumed or produced in quantities that do not maximise economic welfare.

Question 7

public good

Answer 7

Public good: a good that is non-excludable and non-rival in consumption.

Question 8

non-excludable

Answer 8

Non-excludable: where it is not possible to prevent non-paying customers from consuming a good.

Question 9

non-rival

Answer 9

Non-rival: where one person’s enjoyment of a good does not diminish another person’s enjoyment of the good.

Question 10

private good

Answer 10

Private good: a good that is rival and excludable in consumption.

Question 11

free-rider problem

Answer 11

The free-rider problem
Public goods are an example of complete market failure, as the free market would have no incentive to provide them. For example, in the case of sea defences such as flood protection, coastal homeowners would have an incentive to wait for their neighbours or others in a similar situation to fund the flood protection and thus it will not be provided at all. This is referred to as the free-rider problem, since individual consumers hope to get a ‘free ride’ without paying for the benefit they enjoy.

Question 12

Quasi-public good

Answer 12

Quasi-public good: a good which exhibits some, but not all, of the characteristics of a public good, i.e. it is partially non-excludable and/or partially non- rival.

Question 13

externality

Answer 13

Externality: a knock-on effect of an economic transaction upon third parties.

Question 14

positive externality

Answer 14

Positive externality: a positive knock-on effect of an economic transaction upon third parties, also known as an external benefit.

Question 15

positive externalities in production

Answer 15

this case, it is said that the private costs to the firm are greater than the costs to society (diagram)

Question 16

positive externalities in consumption

Answer 16

Positive externalities in consumption occur when the actions of an individual consumer have positive knock-on impacts on others in society

Question 17

negative externalities in consumption

Answer 17

Negative externalities in consumption
In this situation individuals consume ‘too much’ of a product, as shown in Figure 8.4, and the benefits to the individual consumer exceed the benefits to society. In the case of goods such as less-healthy foods, alcohol, tobacco and drugs, individual consumers/users fail to appreciate that society may not benefit as much from their consumption. Indeed, information failure may explain some of the over-consumption of such goods if people become intoxicated or addicted and less able to make ‘rational’ decisions. Thus there is overlap with the concept of demerit goods.

Question 18

negative externalities in production

Answer 18

Negative externalities in production
Negative externalities in production may arise if a firm fails to take into account the wider negative impacts of their activities upon society, i.e. there are external costs. A coastal oil refinery not obliged to account for its wider impact may pollute the atmosphere and local beaches with its emissions and waste products. This will clearly have negative consequences for groups beyond the owners of the factory, including health and environmental consequences. In these situations, social costs exceed the private costs of production (such as raw materials and wages). The market failure arises because output is greater than the social optimum and the price is too low to take full account of all costs of production, including external costs, as shown in Figure 8.3.

Question 18

negative externality

Answer 18

Negative externality: a negative knock-on effect of an economic transaction upon third parties, also known as an external cost.

Question 19

Environmental market failure

Answer 19

Environmental market failure: negative externalities arising from the over-exploitation of environmental resources.

One reason for environmental market failures is a lack of clearly defined property rights relating to environmental resources such as the oceans, the forests or the atmosphere. Economic agents such as individual firms or consumers therefore do not suffer any penalty for polluting the atmosphere, dumping waste in the oceans, or excessive deforestation, for example. This leads to over-use of these resources and the rapid depletion of non-renewable resources.

Question 20

property rights

Answer 20

Property rights: the legal rights of ownership or use of an economic resource.

Question 21

Tragedy of the commons:

Answer 21

Tragedy of the commons: the over-use or exploitation of resources such as the oceans, the forests or the atmosphere that are not owned by individuals or organisations.

Question 22

Merit good:

Answer 22

Merit good: a good that would be under-consumed in a free market.

Question 23

Demerit good:

Answer 23

Demerit good: a good that would be over-consumed in a free market.

Question 24

Imperfect Information:

Answer 24

Imperfect information: when economic agents do not know everything they need to know in order to make a fully informed decision.

Question 25

Asymmetric information:

Answer 25

Asymmetric information: a source of information failure where one economic agent knows more than another, giving them more power in a market transaction.

Question 26

Occupational immobility:

Answer 26

Occupational immobility: a source of factor immobility that means workers find it difficult to move between occupations for reasons of lack of desirable skills.

Question 27

Geographical immobility:

Answer 27

Geographical immobility: a source of factor immobility that means workers have difficulty in moving to locations where jobs are available for reasons such as a lack of affordable housing or family commitments.

Question 28

Equity:

Answer 28

Equity: the notion of fairness in society.

Question 28

Indirect tax:

Answer 28

Indirect tax: a tax on spending, sometimes used to reduce consumption of demerit goods.

Question 29

Subsidy:

Answer 29

Subsidy: a payment made to producers to encourage increased production of a good or service.

Question 30

Minimum price:

Answer 30

Minimum price: a price floor placed above the free market equilibrium price.

Question 31

regulation:

Answer 31

Regulation: rules or laws used to control or restrict the actions of economic agents in order to reduce market failure.

Question 32

Pollution permit:

Answer 32

Pollution permit: the right to use or exploit an economic resource to a specific degree, e.g. a fishing permit or permits to release CO2 into the atmosphere.

Question 33

Competition policy:

Answer 33

Competition policy: government policy which aims to make markets more competitive.

Question 34

theoretical principles underpinning UK competition policy:

Answer 34

The main theoretical principles underpinning UK competition policy include the following: * Ignoring economies of scale, perfect competition is more likely to be productively and allocatively efficient than monopoly. * Monopolists restrict output to raise price and gain supernormal profit. This results in a net loss of welfare as consumer surplus is reduced and producer surplus is increased.

Question 35

Merger:

Answer 35

Merger: when two or more firms willingly join together.

Question 36

Public ownership:

Answer 36

Public ownership: government ownership of firms, industries or other assets.

Question 37

Nationalisation:

Answer 37

Nationalisation: the transfer of assets from the private sector to public ownership.

Question 38

Privatisation:

Answer 38

Privatisation: the sale of state-owned enterprises to the private sector.

Question 39

Regulation:

Answer 39

Regulation: the imposition of rules and laws which restrict market freedom.

Question 40

Regulatory Capture:

Answer 40

Regulatory capture: when the regulatory bodies (such as OFGEM in the case of gas and electricity suppliers) set up to oversee the behaviour of privatised monopolies come to be unduly influenced by the firms they have been set up to monitor.

Question 41

Deregulation:

Answer 41

Deregulation: the removal of rules and regulations in order to increase the efficiency of markets.

Question 42

Government failure:

Answer 42

Government failure: when government intervention in a market reduces overall economic welfare.