Market Failure Flashcards
(215 cards)
1
Q
What is the price mechanism?
A
A very efficient method of allocation scarce resources amongst competing uses in the absence of market failure.
2
Q
What is allocative efficiency?
A
Occurs when price = marginal cost.
3
Q
What does P > MC signify?
A
The value consumers place on the unit of the good exceeds the cost of producing that unit.
4
Q
What does P < MC signify?
A
The value consumers place on the unit of the good is less than the cost of producing that unit.
5
Q
What is market failure?
A
Exists when the competitive outcome of markets is not efficient (or equitable) from the point of view of the economy as a whole.
6
Q
What is complete market failure?
A
Occurs when the market does not supply products at all - there is a missing market.
7
Q
Give examples of complete market failure.
A
- Public goods
- Some information failure such as asymmetric information
- Lack of property rights
8
Q
What is partial market failure?
A
Occurs when the market functions/exists, but it supplies the wrong quantity of a product.
9
Q
Give examples of partial market failure.
A
- 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
10
Q
What is the rationale for government intervention in markets?
A
Market failure provides a rationale for the government to intervene to correct the market failure or at least reduce it.
11
Q
List some policies available for government intervention.
A
- Indirect taxes
- Subsidies
- Regulations
- Bans
- Free provision at point of use
- Price controls (maximum or minimum prices)
- Competition policy
- Redistributive policies
12
Q
What is government failure?
A
Occurs if the government fails to improve the allocation of resources or makes it worse.
13
Q
Fill in the blank: Allocative efficiency occurs when price = _______.
A
[marginal cost]
14
Q
True or False: Market failure can be both complete and partial.
A
True
15
Q
What are private goods?
A
Goods and services supplied and sold through markets by private sector businesses
Characteristics include excludable, rival, and rejectable.
16
Q
What does it mean for a good to be excludable?
A
Buyers can be excluded from benefiting from the good if they are not willing or able to pay for it.
17
Q
Define rival in the context of private goods.
A
One person’s consumption of a product reduces the amount left for others to consume and benefit from.
18
Q
What does rejectable mean for private goods?
A
Can be rejected by the consumer if their needs and preferences or their budget changes.
19
Q
What are public goods?
A
Goods defined by their characteristics of being non-excludable, non-rival, and non-rejectable.
20
Q
What does non-excludable mean?
A
Once a good is provided, it is impossible to prevent people from using and benefiting from it.
21
Q
Explain non-rival goods.
A
Consumption of a good by one person does not prevent or reduce the benefits to another person consuming the good.
22
Q
What is meant by non-rejectable in public goods?
A
The collective supply of a pure public good means it cannot be rejected by people.
23
Q
What is a pure public good?
A
Non-excludable and non-rival all of the time, e.g. national defence, security, mass vaccination.
24
Q
Define quasi public goods.
A
Have some, but not all public good characteristics, e.g. TV & radio broadcasting, toll bridge.
25
How can technological advances affect public goods?
Can change a pure public good into a quasi-public good or a quasi-public good into a private good.
26
What are public bads?
Non-excludable and non-rival, but provide dissatisfaction to people who consume, e.g. flytipping, air pollution.
27
What is the free rider problem?
Someone who consumes a good without paying for it.
28
Why is there a free rider problem with public goods?
It is difficult to charge consumers once a good has been provided due to non-excludability.
29
What is the impact of the free rider problem on demand curves?
Consumers do not reveal their preferences, leading to no demand curve in the market.
30
What happens to producers due to the free rider problem?
There is no incentive for producers to supply the good because it will not be profitable.
31
What is complete market failure?
The free market will fail to provide pure public goods.
32
What is partial market failure?
Under-provision is likely to occur for quasi-public goods.
33
What is one possible solution to market failure of public goods?
Government provision through taxation.
34
How can government funding address market failure?
The government could fund private provision financed through taxation or charges.
35
What roles do voluntary or charitable donations play in public goods?
Examples include organizations like RNLI.
36
How might communities address public goods issues?
Communities may act altruistically and pay collectively, e.g. private road.
37
What is one advantage of government provision of public goods?
Equity - all people have access to public goods regardless of income.
38
What is an efficiency advantage of collective provision?
Allows economies of scale.
39
What is a disadvantage of government provision?
Government may lack the information needed to provide the best amount of public goods.
40
What is a potential disadvantage of government funding of private sector provision?
It is often costly and wasteful.
41
What is a concern regarding public sector investment?
Government corruption issues.
42
What is a minimum price?
A government-set price to prevent the market price from falling below a certain level.
## Footnote
Also known as a price floor.
43
What is a guaranteed minimum price?
The government buys up excess supply to guarantee the minimum price, e.g., some agricultural minimum prices.
## Footnote
This ensures producers receive a stable income.
44
What is a legal minimum price?
A price set by law, prohibiting sales below that price, without government buying up surplus.
## Footnote
Example: minimum price of alcohol.
45
What are the rationales for setting minimum prices?
* Support incomes and jobs of producers
* Encourage investment and innovation
* Discourage consumption of harmful goods
* Prevent consumer abuse of monopsony power
46
What happens when a minimum price is set above the market price?
It causes excess supply and a contraction in demand.
## Footnote
The new quantity demanded is Qd, and quantity supplied is Qs.
47
What are the consequences of a minimum price?
* Surplus of the good
* Disequilibrium at minimum price
* Loss of signalling and incentivising functions
* Suppliers reduce supply
48
What is the cost to the government when it buys up surplus at a guaranteed minimum price?
Cost = QdABQs, which includes expenses for storing, selling, or destroying the surplus.
## Footnote
This may lead to potential government failure.
49
What are some examples of minimum prices?
* Minimum price for alcohol
* Agricultural support prices
* National minimum/living wage
* Minimum care worker price
* Guaranteed prices for renewable energy suppliers
50
What problems arise from minimum prices?
* Excess supply needs addressing
* Suppliers cut supply, output, and jobs
* Buying surplus can be expensive
* Opportunity costs from government intervention
51
Fill in the blank: A minimum price set by law is known as a _______.
[legal minimum price]
52
True or False: A guaranteed minimum price means the government will not buy excess supply.
False
## Footnote
The government intervenes to buy up the surplus.
53
What can the government do if it believes the market price is too low?
* Impose indirect taxes
* Provide information
* Implement regulations
* Enforce bans/restrictions
* Offer direct grants to producers
54
What is a minimum price?
A government-set price to prevent the market price from falling below a certain level.
## Footnote
Also known as a price floor.
55
What is a guaranteed minimum price?
The government buys up excess supply to guarantee the minimum price, e.g., some agricultural minimum prices.
## Footnote
This ensures producers receive a stable income.
56
What is a legal minimum price?
A price set by law, prohibiting sales below that price, without government buying up surplus.
## Footnote
Example: minimum price of alcohol.
57
What are the rationales for setting minimum prices?
* Support incomes and jobs of producers
* Encourage investment and innovation
* Discourage consumption of harmful goods
* Prevent consumer abuse of monopsony power
58
What happens when a minimum price is set above the market price?
It causes excess supply and a contraction in demand.
## Footnote
The new quantity demanded is Qd, and quantity supplied is Qs.
59
What are the consequences of a minimum price?
* Surplus of the good
* Disequilibrium at minimum price
* Loss of signalling and incentivising functions
* Suppliers reduce supply
60
What is the cost to the government when it buys up surplus at a guaranteed minimum price?
Cost = QdABQs, which includes expenses for storing, selling, or destroying the surplus.
## Footnote
This may lead to potential government failure.
61
What are some examples of minimum prices?
* Minimum price for alcohol
* Agricultural support prices
* National minimum/living wage
* Minimum care worker price
* Guaranteed prices for renewable energy suppliers
62
What problems arise from minimum prices?
* Excess supply needs addressing
* Suppliers cut supply, output, and jobs
* Buying surplus can be expensive
* Opportunity costs from government intervention
63
Fill in the blank: A minimum price set by law is known as a _______.
[legal minimum price]
64
True or False: A guaranteed minimum price means the government will not buy excess supply.
False
## Footnote
The government intervenes to buy up the surplus.
65
What can the government do if it believes the market price is too low?
* Impose indirect taxes
* Provide information
* Implement regulations
* Enforce bans/restrictions
* Offer direct grants to producers
66
What is government failure?
Government intervention worsens the allocation of scarce resources
## Footnote
It results in a greater net welfare loss and the cost of the intervention outweighs the benefits gained.
67
What are the causes of government failure?
* Political self-interest
* Regulatory capture
* Poor value for money
* Conflicting objectives
* Policy short-termism
* Bureaucracy and red tape
## Footnote
These factors can hinder effective policy implementation and outcomes.
68
What are some outcomes of government failure?
* Greater inequality
* High costs of compliance and implementation
* Possible unintended consequences
* Conflicts with other objectives
* Poor policy choice/outcomes
* Ineffective in changing behaviour
## Footnote
Outcomes can negatively impact lower-income households and overall economic efficiency.
69
Define unintended consequences.
Outcomes that were not foreseen and intended by the government action
## Footnote
At least one unintended consequence is often present, with some being positive but negative ones causing concern.
70
What is the Law of Unintended Consequences?
It states that it is impossible for the government to predict outcomes accurately for the economy
## Footnote
These outcomes are inevitable and can deepen existing market failures.
71
Give an example of an unintended consequence of a minimum wage.
Reduction in non-wage benefits for workers
## Footnote
This may lead to overall poorer compensation for employees.
72
What is a possible unintended consequence of an indoor smoking ban?
Increased use of environmentally-unfriendly patio heaters
## Footnote
This highlights how regulations can lead to negative environmental impacts.
73
What is a potential consequence of tariffs to protect the steel industry?
Increased costs for car makers and house builders
## Footnote
Tariffs can lead to higher prices and reduced competitiveness in other sectors.
74
What might charging for plastic bags encourage?
A switch to canvas bag use, which could be worse for the environment
## Footnote
This demonstrates how well-intentioned policies can have adverse effects.
75
What are arguments against government intervention in markets?
* Likelihood of significant government failure
* Price mechanism efficiency
* Higher prices as a good outcome when resources are scarce
* Profit motive incentivising businesses
## Footnote
These arguments suggest that market forces can often work better without intervention.
76
What are arguments for government intervention in markets?
* Allocation of property rights
* Provision of public goods
* Macroeconomic stability
* Measures to reduce inequality
* Rules about competition
## Footnote
These features are essential for an economy to function effectively.
77
What is considered possibly the biggest government failure?
Inaction by the government
## Footnote
Failure to act in the face of market failure can exacerbate economic issues.
78
What are the three functions of prices in markets?
Signalling, incentivising, rationing
79
What does the signalling function of prices indicate to producers?
To adjust their output levels
80
What does the signalling function of prices indicate to consumers?
To re-think how much they will purchase
81
How can higher prices incentivise producers?
By anticipating more profit
82
How can lower prices incentivise consumers?
By allowing them to pay less for a good yielding the same utility
83
What happens to the price when supply is limited?
The price rises
84
What does consumer surplus measure?
Consumer welfare
85
What is the definition of consumer surplus?
The difference between what consumers are willing to pay and what they actually pay
86
What does producer surplus measure?
Producer welfare
87
What is the definition of producer surplus?
The difference between what producers are willing to supply for and the price they actually receive
88
What can cause the signalling function of prices to fail?
Externalities, government price controls, non-equilibrium prices, imperfect information
89
What may be missing for public goods in terms of price functions?
Incentivising
90
How does government price setting affect rationing?
It may prevent rationing from working effectively
91
What happens to consumer surplus if supply increases?
It will increase
92
Fill in the blank: Consumer surplus is indicated by the _______.
Demand curve
93
Fill in the blank: Producer surplus is indicated by the _______.
Supply curve
94
What is the area representing consumer surplus in a diagram?
Area APB
95
What is the area representing producer surplus in a diagram?
Area APC
96
True or False: A rise in market price always increases consumer surplus.
False
97
True or False: A rightward shift in demand leads to an increase in producer surplus.
True
98
What are information gaps?
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.
## Footnote
This situation can result in market failure.
99
What is market failure?
Market failure refers to market imperfections that prevent the allocation of resources from being efficient.
## Footnote
It occurs when the market fails to allocate resources efficiently or equitably.
100
What happens when consumers have full information?
Consumers would demand more because they are aware of the extra societal benefits.
## Footnote
This occurs due to the information gap causing under-consumption.
101
What is the result of an information gap on consumption?
An information gap can cause under-consumption or over-consumption depending on the awareness of societal benefits or costs.
## Footnote
Under-consumption occurs when consumers are unaware of benefits, while over-consumption occurs when they are unaware of costs.
102
Give examples of information failure.
Examples include:
* Risks from using tanning salons
* Addiction to painkillers and other drugs
* Complexity of pension schemes
* Uncertain quality of second-hand goods
* Knowledge of the nutritional content of food
* Cowboy builders and other rip-off merchants
* Tourist bazaars or buying and selling antiques
## Footnote
These examples illustrate various scenarios where consumers lack essential information.
103
What is factor mobility?
Factor mobility occurs when factors of production can easily be moved from one use to another.
## Footnote
It is essential for efficient resource allocation.
104
What is geographical immobility of labour?
Geographical immobility of labour refers to the inability of workers to move freely across regions due to factors like regional house price variation, family ties, and children in school.
## Footnote
This can restrict the availability of labour in certain areas.
105
What causes occupational immobility of labour?
Occupational immobility can occur due to insufficient education and training, a lack of transferable skills, or inability to afford training.
## Footnote
This limits workers from transitioning to different jobs.
106
How is land mobility characterized?
Land is not geographically mobile but can be occupationally mobile, such as land used for agriculture or housing.
## Footnote
This means land can be repurposed but cannot easily move locations.
107
What is the mobility of capital?
Capital can be both occupationally and geographically mobile, but heavy industry capital may not be mobile at all.
## Footnote
For example, hand tools are easily movable, while a blast furnace is not.
108
What are the consequences of factor immobility?
Factor immobility can cause structural unemployment and regional inequality, leading to market failure.
## Footnote
This occurs when resources cannot be reallocated efficiently.
109
What is a monopoly?
A monopoly is a market structure where a single seller controls the entire market for a product or service.
## Footnote
This can lead to market power and influence over prices.
110
How can a monopoly affect prices?
A monopoly can restrict output to increase price to maximize its profits.
## Footnote
This behavior typically results in higher prices than in competitive markets.
111
What is the relationship between monopoly price and market price?
The monopoly price (Pmon) is higher than the market price (P).
## Footnote
This illustrates the price manipulation by monopolies.
112
What is the impact of monopoly on social welfare?
A monopoly causes a loss of social welfare, reducing both consumer and producer surpluses.
## Footnote
This behavior leads to market failure.
113
What is the monopoly output compared to market equilibrium output?
The monopoly output (Qmon) is less than the market equilibrium output.
## Footnote
This indicates inefficiencies created by monopolistic practices.
114
What are merit goods?
Goods/services that the government judges will be under-consumed and should be subsidised or provided free at the point of use.
115
What is a key characteristic of merit goods?
People do not fully understand the private benefits of their consumption.
116
What type of externalities do merit goods often generate?
Positive externalities.
117
Provide three examples of merit goods.
* Healthcare
* Dental care
* Education
118
What is required to classify a good as a merit or demerit good?
A value judgement.
119
What are demerit goods?
Goods/services that the government judges will be over-consumed and should be taxed or regulated.
120
What is a key characteristic of demerit goods?
People do not fully understand the private costs of their consumption.
121
What type of externalities do demerit goods often generate?
Negative externalities.
122
Provide three examples of demerit goods.
* Tobacco
* Alcohol
* Gambling
123
What does the merit good diagram illustrate?
A merit good where there is information failure and positive externalities.
124
In the merit good diagram, what does Q1Q* represent?
The market underprovides by Q1Q*.
125
What does Q1Q2 indicate in the merit good diagram?
Underprovision due to consumers not fully understanding the benefits.
126
What is the difference between MSB and MPB in the context of merit goods?
MSB (Marginal Social Benefit) exceeds MPB (Marginal Private Benefit).
127
What does the demerit good diagram illustrate?
A demerit good where there is information failure and negative externalities.
128
In the demerit good diagram, what does Q1Q* represent?
The market overprovides by Q1Q*.
129
What does Q1Q2 indicate in the demerit good diagram?
Overprovision due to consumers not fully understanding the costs.
130
What is the relationship between MSB and MPB in the context of demerit goods?
MSB is greater than MPB.
131
What is one reason consumers face information gaps according to behavioral economics?
Consumers do not always act on full information even when they have it.
132
Fill in the blank: Merit goods suffer from _______.
information failure.
133
Fill in the blank: Demerit goods suffer from _______.
information failure.
134
True or False: Not all goods with positive consumption externalities are merit goods.
True.
135
True or False: Not all goods with negative consumption externalities are demerit goods.
True.
136
What is a negative production externality?
A third party or spillover external cost arising from the production of a good for which no compensation is paid, e.g. pollution.
## Footnote
Negative production externalities occur when the production process negatively affects third parties, such as through environmental harm.
137
What is a negative consumption externality?
A third party or spillover external cost arising from the consumption of a good for which no compensation is paid, e.g. tobacco consumption causing passive smoking.
## Footnote
Negative consumption externalities are often associated with demerit goods, which have adverse effects on society.
138
Define social benefit.
Social benefit = private benefit + external benefit.
## Footnote
This formula accounts for both the benefits received by individuals and the benefits to society as a whole.
139
Define social cost.
Social cost = private cost + external cost.
## Footnote
This formula combines the costs incurred by producers and the costs imposed on society.
140
What does MPC stand for?
MPC = marginal private cost.
## Footnote
It represents all the costs of producing one more unit of the good to the producer.
141
What does MSC stand for?
MSC = marginal social cost.
## Footnote
It includes all the costs of producing one more unit of the good to society.
142
What does MPB stand for?
MPB = marginal private benefit.
## Footnote
It indicates all the benefits of consuming one more unit of the good to the consumer.
143
What does MSB stand for?
MSB = marginal social benefit.
## Footnote
This represents all the benefits of consuming one more unit to society.
144
When is allocative efficiency achieved in a perfect market?
Allocative efficiency is achieved when P = MC.
## Footnote
However, in the presence of externalities, social optimum occurs when MSC = MSB.
145
What is the polluter pays principle?
A principle that requires those who produce pollution to bear the costs associated with it.
## Footnote
This approach aims to internalize external costs and reduce negative externalities.
146
List some policies to address negative externalities.
* Indirect taxes
* Tradeable pollution permits
* Banning/restricting output
* Legislation/regulations
* 'Nudge' policies
## Footnote
These policies aim to internalize external costs and mitigate market failures.
147
What does it indicate when MSC > MPC?
It indicates overproduction in the market.
## Footnote
The social optimum occurs where MSC = MSB, which is less than the market equilibrium quantity.
148
What happens in a negative consumption externality scenario?
MSB < MPB, leading to over-provision and over-consumption.
## Footnote
This results in too many scarce resources being allocated to the production and consumption of the good.
149
Examples of negative production externalities include:
* Air pollution
* Noise pollution
* Water pollution
* Environmental damage
## Footnote
These externalities arise from industrial processes and other production activities.
150
Examples of negative consumption externalities include:
* Tobacco
* Alcohol
* Gambling
* Obesity
* Congestion
## Footnote
These externalities often lead to broader societal issues and costs.
151
What is an indirect tax?
A tax imposed on producers by the government that may be passed on to consumers through higher prices
## Footnote
Examples include duties on cigarettes, alcohol, fuel, the sugar levy, VAT, and carbon taxes.
152
What is tax incidence?
How the final burden of a tax is shared between producers and consumers.
153
If demand for a good is price elastic, who bears more of the tax burden?
The producer.
154
If demand for a good is price inelastic, who bears more of the tax burden?
The consumer.
155
What is the difference between specific tax and ad valorem tax?
Specific tax is a parallel shift, while ad valorem tax is a pivotal shift.
156
What happens to the supply curve when an indirect tax is imposed?
The supply curve shifts up from S to S+tax.
157
What is the new equilibrium price after an indirect tax is imposed?
Price rises to P2.
158
What is the effect of an indirect tax on quantity sold?
Quantity falls to Q2.
159
How is tax revenue calculated after an indirect tax is implemented?
Tax revenue = tax per unit x quantity sold after tax.
160
What is a disadvantage of indirect taxes?
They can be regressive.
161
What is one advantage of using indirect taxes?
They correct market failures.
162
List some disadvantages of indirect taxes.
* Hard to determine the best size of tax
* Compliance costs
* Possible tax avoidance or evasion
* Shadow market activity
* Government failure/unintended consequences
163
List some advantages of indirect taxes.
* Deters consumption of harmful goods
* Source of revenue for government
* Helps tackle climate change
164
True or False: Indirect taxes can lead to government failure.
True.
165
Fill in the blank: Tax incidence on the consumer can be found by looking at the increase in the _______.
[market price].
166
What is an indirect tax?
A tax imposed on producers by the government that may be passed on to consumers through higher prices
## Footnote
Examples include duties on cigarettes, alcohol, fuel, the sugar levy, VAT, and carbon taxes.
167
What is tax incidence?
How the final burden of a tax is shared between producers and consumers.
168
If demand for a good is price elastic, who bears more of the tax burden?
The producer.
169
If demand for a good is price inelastic, who bears more of the tax burden?
The consumer.
170
What is the difference between specific tax and ad valorem tax?
Specific tax is a parallel shift, while ad valorem tax is a pivotal shift.
171
What happens to the supply curve when an indirect tax is imposed?
The supply curve shifts up from S to S+tax.
172
What is the new equilibrium price after an indirect tax is imposed?
Price rises to P2.
173
What is the effect of an indirect tax on quantity sold?
Quantity falls to Q2.
174
How is tax revenue calculated after an indirect tax is implemented?
Tax revenue = tax per unit x quantity sold after tax.
175
What is a disadvantage of indirect taxes?
They can be regressive.
176
What is one advantage of using indirect taxes?
They correct market failures.
177
List some disadvantages of indirect taxes.
* Hard to determine the best size of tax
* Compliance costs
* Possible tax avoidance or evasion
* Shadow market activity
* Government failure/unintended consequences
178
List some advantages of indirect taxes.
* Deters consumption of harmful goods
* Source of revenue for government
* Helps tackle climate change
179
True or False: Indirect taxes can lead to government failure.
True.
180
Fill in the blank: Tax incidence on the consumer can be found by looking at the increase in the _______.
[market price].
181
What is the Tragedy of the Commons?
When no one owns a resource, it may get over-used, leading to environmental degradation and depletion
## Footnote
Examples include fish stocks and deforestation.
182
What is market failure in environmental economics?
The situation where natural resources are over-used, leading to negative environmental impacts.
183
What is a tradeable permit scheme?
A market-based system for reducing greenhouse gas emissions, also known as cap-and-trade.
184
What does a cap-and-trade system entail?
The government sets a limit on total emissions and issues permits to companies for a certain amount of emissions.
185
What is a carbon tax?
An indirect tax on producers that raises the price of carbon emissions.
186
What are the advantages of a carbon tax?
* Mandates a specific price on carbon
* Makes the polluter pay
* Internalises the externality
* Incentivises lower emissions
* Revenue can be spent on environmental initiatives
187
What happens if a company emits less than its allotted amount of carbon?
It can sell its surplus allowances to another company that has exceeded its limit.
188
What are the potential problems with implementing a carbon tax?
* Difficulty in determining the correct tax size
* Demand may be price inelastic
* Potential loss of international competitiveness
* Could be regressive
* Costs of compliance and tax evasion
* Countries may 'free ride'
189
What does the carbon tax do to the Marginal Private Cost (MPC)?
It shifts the MPC up, leading to a new market equilibrium.
190
What is the social optimum in the context of carbon taxation?
The quantity where Marginal Social Benefit (MSB) equals Marginal Social Cost (MSC).
191
What are some other green policies aside from carbon tax?
* Other green taxes (e.g. fuel duty, air passenger duty, landfill tax)
* Subsidies for green energy
* Regulations for net zero
* Behavioral changes like waste reduction
* Voluntary carbon footprint offsetting
192
Fill in the blank: A carbon tax has eliminated the welfare loss, internalised the externality, and made the _______ pay.
polluter
193
True or False: The carbon tax can lead to an increase in pollution.
False
194
What is a maximum price?
A maximum price is a price set by the government or an industry regulator to prevent the market price from rising above a certain level.
## Footnote
Also known as a price cap or price ceiling.
195
What is the rationale for setting maximum prices?
* To make necessities more affordable, especially for those on low incomes
* To encourage consumption of goods that are good for social welfare
* To prevent businesses from profiteering at the expense of consumers
## Footnote
Positive externalities may also justify maximum pricing.
196
What happens when a maximum price is set below the market price?
A new quantity demanded increases, while the quantity supplied decreases, leading to excess demand.
## Footnote
This results in a shortage of the good.
197
What is the impact of a maximum price on market equilibrium?
The maximum price causes a shortage and creates disequilibrium in the market.
## Footnote
The price loses its rationing function.
198
How might a government ration goods when a maximum price causes excess demand?
* First come, first served
* Waiting lists
* Preferred customer priority
* Ration books
* Shadow market activity
## Footnote
These methods may lead to inefficiencies.
199
What are potential consequences of maximum price controls?
* Shortage of goods
* Disequilibrium in the market
* Government failure and unintended consequences
## Footnote
These consequences can complicate the market further.
200
List some examples of maximum prices in markets.
* Bus fare price cap
* Cap on interest rates charged by payday lenders
* Energy price cap
* Cap on university tuition fees
* Currency pegs
* Cap on mobile phone roaming charges
* Cap on bonuses and CEO pay
* Price caps for water companies
* Cap on annual charges for occupational pension plans
* Ticket prices for events
## Footnote
These examples illustrate various applications of price controls.
201
What problems are associated with maximum prices?
* Excess demand needs addressing
* Alternative rationing methods may not work well
* Suppliers may leave the market if profits are insufficient
* Better alternative policies may exist, such as subsidies or redistribution
## Footnote
These issues can exacerbate market shortages.
202
True or False: Maximum prices can lead to a reduction in the supply of goods.
True
## Footnote
Suppliers may exit the market if they cannot charge a profitable price.
203
Fill in the blank: A maximum price is also known as a _______.
price cap
## Footnote
It serves to limit how high prices can go in the market.
204
What are producer subsidies?
Payments to producers by the government to reduce costs of production
## Footnote
Example: subsidies for renewable energy
205
What are consumer subsidies?
Payments to consumers to allow them to purchase more of a good/service
## Footnote
Example: childcare vouchers
206
What is the impact of a producer subsidy on supply?
Shifts supply right
## Footnote
This occurs as the subsidy reduces production costs.
207
What happens to price and quantity at the new equilibrium after a subsidy?
Price falls to P2 and quantity rises to Q2
## Footnote
Starting equilibrium price is P1 and quantity is Q1.
208
What is the total cost of a subsidy?
Subsidy per unit AB x quantity sold after subsidy Q2
## Footnote
This is represented by the shaded area ABCP2.
209
List three advantages of producer subsidies.
* Corrects market failures
* Encourages consumption of beneficial goods
* Helps protect producer incomes and jobs
210
List three disadvantages of producer subsidies.
* Cost to government (opportunity cost)
* Firms may become over-reliant on subsidy
* May cause fraud/corruption
211
If demand for a good is price elastic, who mainly benefits from a subsidy?
The producer
## Footnote
Producer gains area P1FBC.
212
If demand for a good is price inelastic, who mainly benefits from a subsidy?
The consumers
## Footnote
Consumers gain area P1P2AF.
213
What should be evaluated to determine if subsidies are meeting their aims?
Size and scope of the subsidy, elasticity of demand or supply
## Footnote
Also consider opportunity cost and market failure correction.
214
True or False: Subsidies always promote efficiency.
False
## Footnote
The effectiveness of subsidies in promoting efficiency can vary.
215
What is a potential unintended consequence of subsidies?
Government failure
## Footnote
This can occur alongside other unintended consequences.
