Market Failure

Question 1

When does Market Failure exist?

Answer 1

Market failure exists when the competitive outcome of markets is not efficient from the point of view of the economy as a whole

ie resources are not allocated as efficiently as they could be.

Question 2

Allocative efficiency occurs when ____ = marginal cost.

Answer 2

Price

P>MC: If the value consumers place on the unit of the good exceeds the cost of producing that unit, it is efficient to allocate scarce resources to the production of that good.

P<MC: If the value consumers place on the unit of the good is less
than the cost of producing that unit, it is efficient to allocate scarce resources to the production of that good.

Question 3

What is Complete Market Failure?

Answer 3

Complete market failure occurs when the market does not supply products at all – there is a missing market.

Examples: public goods, some information failure such as asymmetric information, when there is a lack of property rights

Question 4

What is Partial Market Failure?

Answer 4

Partial market failure occurs when the market functions/exists, but it
supplies the wrong quantity of a product.

Examples:
• Negative externalities from production and consumption

• Positive externalities from production and consumption

• Some information gaps

• Market concentration and frictions

• Irrationality (linked to behavioural economics).

• Inequality (some groups are not able to express their preferences
through effective demand)

• Volatile prices

• Market pirices is deemed too high or too low by the government

• Merit goods

• Demerit goods

Question 5

What are some examples of Policies the Government can use to correct Market Failure?

Answer 5

• Indirect taxes

• Subsidies

• Regulations

• Bans

• Free provision at point of use

• Price controls (maximum or minimum prices)

• Competition policy

• Redistributive policies

Question 6

What is it known as when the Government fail to improve the allocation of resources or worsen them?

Answer 6

Government failure

Question 7

What is the Free-Rider Problem?

Answer 7

Free rider - someone who consumes a good without paying for it.

Because public goods are non-excludable, it is difficult to charge
consumers once a good has been provided – there is a free rider problem.

• Consumers do not reveal their preferences if they think they can free ride

• This means there is no demand curve in the market

• There is no incentive for producers to supply the good because it will
not be profitable

• The market is missing – resources are not allocated to produce public
goods, even though consumers may actually want them

The free market will fail to provide pure public goods (complete market failure).

For quasi-public goods, under=provision is still likely to occur (partial market failure).

Question 8

What are the Characteristics of Private Goods?

Answer 8

Private goods are goods and services supplied and sold through markets by private sector businesses.

They are:
• Excludable – buyers can be excluded from benefiting from the good if they are not willing or able to pay for it

• Rival - one person’s consumption of a product reduces the amount left for others to consume and benefit from

• Rejectable - can be rejected by the consumer if their needs and
preferences or their budget changes

Question 9

What are the Characteristics of Public Goods?

Answer 9

• Non-excludable – once a good is provided it is impossible to prevent people from using and benefiting from it; non-payers can enjoy the benefits for free creating a ‘free rider’ problem.

• Non-rival (or non-diminishable) - consumption of a good by one person does not prevent or reduce the benefits to another person consuming the good.

• Non-rejectable – the collective supply of a pure public good means it cannot be rejected by people.

Question 10

What is a Pure Public Good?

Answer 10

Non-excludable and non-rival all of the time

E.g. national
defence, security, mass vaccination

Question 11

What is a Quasi-Public Good? (Semi-Public)

Answer 11

These goods have some, but not all public good characteristics

i.e. it has one or other
characteristics, or has both some of the time, but not all of the time.

e.g. TV & radio broadcasting, toll bridge

Technological advances can change a pure public good into a quasi-public good or a quasi-public good into a private good

Question 12

What are Public Bads?

Answer 12

Public bads are non-excludable and non-rival, but provide dis-satisfaction to people who consume

Eg flytipping, air pollution

Question 13

What are some possible solutions to market failure for public goods?

Answer 13

• Government provision
- collective provision through taxation

• Government funding
- the government could fund private provision financed through taxation or charges (eg TV licence)

• **Voluntary/charitable donations **
- eg RNLI

Communities may act altruistically – and pay collectively (eg private road)

Question 14

Advantages of Government Provision?

Answer 14

• Equity – all people, whatever their
income have access to public goods

• Efficiency – collective provision
allows economies of scale

• Overcomes the free rider
problem/missing market

• Public sector investment is higher

Question 15

Disadvantages of Government Provision?

Answer 15

• Government may lack the
information needed to provide best
amount of public goods

• Possible diseconomies of scale

• Government funding of private sector provision is often costly & wasteful

• Government corruption issues

Question 16

What is a Negative Production Externality?

Answer 16

A third party or spillover external cost arising from the production of a good for which no compensation is paid

e.g. air, noise & water pollution, environmental damage

Question 17

What is a Negative Consumption Externality?

Answer 17

A third party or spillover external
cost arising from the consumption of a good for which no compensation is paid

e.g. tobacco, alcohol, gambling, obesity, congestion

Question 18

Social benefit = private ____ + external benefit
Social cost = private ___ + external cost

Answer 18

Benefit

Cost

Question 19

What is MPC (marginal private cost)?

Answer 19

All the costs of producing one more unit of the good to the producer

Question 20

What is MSC (marginal social cost)?

Answer 20

All the costs of producing one more unit of the good to society

Question 21

What is MPB (marginal private benefit)?

Answer 21

All the benefits of consuming one more unit of the good to the consumer

Question 22

What is MSB (marginal social benefit)?

Answer 22

All the benefits of consuming one more unit to society

Question 23

In a perfect market, allocative efficiency is achieved when P = __

Answer 23

MC

Question 24

What is a Positive Consumption Externality?

Answer 24

A third party or spillover external
benefit arising from the consumption of a good for which no compensation is paid

e.g. healthcare, education, dental care, green spaces/parks

Question 25

What is a Positive *Production* Externality?

Answer 25

A third party or spillover external benefit arising from the **production of a good for which no compensation is paid** e.g. fish industry benefitting from a dam built to store water (reservoir); honey producer benefitting from being near an apple orchard, R&D, training and education.

Question 26

Evaluation of Government Policies to reduce/eliminate externalities?

Answer 26

Success of the policy intervention depends on: • Size of externality • The extent to which the externality can be measured • Whether there are unintended consequences from the policy • Whether there is government failure (this could be an information failure) • Opportunity cost of policy – some interventions are expensive • How the policy affect the distribution of income – are there winners and losers? The government needs to judge whether the benefits of intervening are sufficiently high relative to the costs to make it worthwhile for social welfare

Question 27

What is a Merit Good?

Answer 27

Merit goods are those goods/services that the government judges that people will under-consume, and which ought to be subsidised or provided free at the point of use. • People do not fully understand the private benefits of their consumption. • Consumption of merit goods also often generates positive externalities - where the social benefit exceeds the private benefit. Examples: healthcare, dental care, education A *value judgement* must be made to classify a good as a merit or demerit good.

Question 28

What is a Demerit Good?

Answer 28

Demerit goods are those goods/services that the government judges that people will over-consume, and which ought to be taxed or regulated. • People do not fully understand the private costs of their consumption. • Consumption of demerit goods also often generates negative externalities - where the private benefit exceeds the social benefit. Examples: tobacco, alcohol, gambling

Question 29

What is a Demerit Good?

Answer 29

Demerit goods are those goods/services that the government judges that people will over-consume, and which ought to be taxed or regulated. • People do not fully understand the private costs of their consumption. • Consumption of demerit goods also often generates negative externalities - where the private benefit exceeds the social benefit. Examples: tobacco, alcohol, gambling *Behavioural economics can help explain why consumers face information gaps; consumers do not always act on full information even when they have it*

Question 30

When do Information Gaps occur?

Answer 30

Information gaps exist when **either the buyer or seller does not have access to the information needed for them to make a fully-informed decision**, leading to a **misallocation of scarce resources = market failure**

Question 31

What does Geographical Immobility of Labour mean?

Answer 31

In practice, **labour may not be fully mobile** because of regional house price variation, family & social ties, children in school etc. **Capital** can be both occupationally and geographically mobile, eg hand tools or vehicles, but heavy industry capital, eg a blast furnace, may not be mobile at all.

Question 32

What does Occupational Immobility of Labour mean?

Answer 32

Can occur because of **insufficient education and training, a lack of transferable skills, inability to afford training** etc. **Land** is not geographically mobile but can be occupationally mobile, eg land used for agriculture or housing. **Capital** can be both occupationally and geographically mobile, eg hand tools or vehicles, but heavy industry capital, eg a blast furnace, may not be mobile at all.

Question 33

What is **Tragedy Of The Commons**?

Answer 33

**When no one owns a resource, it may get over-used**, for example fish stocks and deforestation - people use and benefit from a common pool resource such as grazing land without regard to the effects on others. Our natural resources are often over-used, leading to **environmental degradation and depletion**.

Question 34

What are some *Green Policies*?

Answer 34

**Carbon tax+* on carbon emissions – an indirect tax on producers that raises the price of emissions **Fuel duty** **Air passenger duty** **Landfill tax** **Subsidies** – for green energy, fitting heat pumps, home insulation **Regulations** – targets for net zero, electric vehicles, renewable energy; energy labelling for homes/appliances **Behavioural changes** – waste reduction & circular economy, nudges (e.g lower default temperature on boiler/showers) **Voluntary carbon footprint offsetting emissions** – e.g. tree planting