Market Failure Flashcards
(19 cards)
What is Market Failure?
Market failure occurs when the free market fails to allocate resources efficiently, resulting in a loss of economic and social welfare.
What are the key causes of Market Failure?
Externalities, public goods, information gaps, market power.
What are Externalities (spill-over effects)?
Externalities are third-party effects caused by economic activities.
What are positive externalities and an example?
Benefits to third parties. E.g. Education as a more educated population benefits society.
What are negative externalities and an example?
Costs to third parties. E.g. Pollution from factories harm local residents’ health.
What are public goods?
Goods that are non-excludable (can’t stop people from using them) and non-rival (one person’s use doesn’t reduce availability for others).
What are examples of public goods?
National defences, streetlights and flood defences.
What is a Free-Rider problem?
People benefit without paying, so private firms have no incentive to provide public goods therefore leading to market failure.
What are information gaps?
This occurs when buyers or sellers don’t have full information about a product or service.
Give an example of information gaps.
Used cars (Lemons problem): Sellers may know more about the car’s quality than buyers.
What is Asymmetric information with an example?
One party knows more than the other, usually sellers know more than buyers. E.g. Car dealers know more about the car they’re selling than the buyer.
What is a Moral Hazard with an example?
People take more risks when they don’t bear the full costs. E.g. Insured cars may drive recklessly.
What is the Principal-Agent problem?
A principal (employer & shareholder) hires or delegates tasks to an agent (an employee, CEO & politician) and the agent has more information acting in their own best interest rather than in the principals best interest. Leads to allocative inefficiency where resources are not used to maximise social welfare.
What is an example of Principal-Agent principle?
A CEO might invest in projects that enhance their reputation but don’t benefit the company’s shareholders.
What are Quasi-public goods and give an example?
These goods are non-excludable and non-rivalrous to an extent. Non-excludable: Some people can use these goods without paying but access restricted (e.g. subscription based services) Non-rival: Overuse can lead to congestion (e.g. overcrowded parks or roads during rush hour).
What is the Marginal Social Benefit (MSB) curve?
In welfare economics this refers to the demand curve. It just means that it reflects the extra benefit of consuming one extra unit of a good or service.
What is the Marginal Social Cost (MSC) curve?
In welfare economics this refers to the supply curve. It just means that it reflects the extra cost of producing one extra unit of a good or service.
What is the community surplus?
Consumer surplus + producer surplus = community surplus. Where MSB of producing/consuming a unit of output is greater than or equal to the MSC of producing a unit of output. Therefore, market equilibrium is where community surplus is maximised.
Problem with externalities?
They lead to markets getting the price wrong. Therefore, markets produce the wrong quantity of the good/service.
