Market failure Flashcards
(100 cards)
1
Q
Advantages of price mechanism
A
- Gives an indication to firms of what goods and services to supply
- ‘invisible hand’ tells consumers price of products and allows for consumer sovereignty where produces have to take into account their wants and needs
2
Q
Disadvantages of price mechanism
A
- Impersonal method of allocating resources- creates inequality
- Production of public goods are ignored by private firms
- information asymmetry and monopoly power lead to consumers being exploited
- firms unable to adapt will go out of business
3
Q
What are public goods
A
- Goods that are non excludable and non rivalrous
4
Q
What is non excludability
A
- Person paying for the benefit cannot prevent anyone else from also benefitting
- Creates ‘free rider’ problem
5
Q
What is non rivalry
A
- One person benefitting from the good doesn’t reduce the amount available for others
6
Q
What is meant by the ‘free rider’ problem
A
Individuals using a good without contributing towards the cost of it
7
Q
Examples of public goods
A
- Street lighting
- National defence
- Police service
8
Q
What is the tragedy of the commons
A
- When every individual tries to benefit from a scarce resource
- Demand outstrips supply and the resource is used up- less and less to go around
- Eventually, there is nothing left and the whole of society suffers as a result- misallocation of resources
9
Q
When could ‘the tragedy of the commons’ occur
A
- If intellectual property rights (IPR) are absent from a market
- Applies to all available resources
10
Q
How can government prevent tragedy of the commons
A
- Government placing restrictions on common usage eg through taxation to stop resource being over exploited
- However difficult to implement internationally
11
Q
What is the rationing function
A
- As prices rise, excess demand is remove and only the consumers with the ability to pay for it are able to purchase the good
12
Q
What is the signalling function
A
- Prices provide important market signals to market participants
- Eg to producers to either increase or decrease production
13
Q
What is the incentive function
A
- Increased prices strengthens incentives for firms to produce more in order to increase profit
14
Q
What is the allocative function
A
- Acts to divert resources where they can maximise their returns and away from uses where they do not
15
Q
Equation to remember for Market failure diagrams
A
- Private + external = social
- External = social - private (rearranged for diagrams)
16
Q
What are externalities
A
- The costs and benefits to a third party created by economic agents when undertaking their activities
17
Q
What are negative externalities
A
- Costs to a third party that are not included in the price
- The divergence between private costs and social costs
18
Q
What are positive externalities
A
- Benefits to a third party that are not included in the price
- The divergence between private benefits and social benefits
19
Q
Examples of negative externalities
A
- Factory creating air pollution from production
- Private costs to firm is cost of making the good
- However the additional social costs are created due to society suffering form poor air quality
20
Q
Examples of positive externalities
A
- A local firm investing heavily into training its workforce
- Private benefit is having well trained employees
- Social benefits also created due to local community having pool of better workers
21
Q
What are private costs
A
- The costs of consuming or producing goods or services that have been paid for by the first and second parties
22
Q
What are social costs
A
- The costs of consuming or producing goods or services that are paid for by society
23
Q
When do negative externalities occur
A
- When social costs are higher than private costs
- External = Social - private, so external cost is +ve
24
Q
What are private benefits
A
- Benefits of consuming or producing goods or services that are received by an economic unit
25
What are social benefits
- Those benefits of producing or consuming goods or services that are received by society
26
When do positive externalities occur
- When social benefits are greater than private benefits
- External = Social - private so external benefits is +ve ( or external cost is -ve)
27
Why do externalities occur
- In a market economy, the economic unit only considers the private costs or benefits, not taking into account social benefits and costs
28
4 categories of externalities
- Negative production externalities
- Negative consumption externalities
- Positive production externalities
- Positive consumption externalities
29
What is a negative production externality
- Over produced if left to free market
30
What is a negative consumption externality
- Over consumed in free market
31
What is a positive consumption externality
- Under consumed in free market
32
What is a positive production externality
- Under produced in free market
33
What curve is split in Production externalities
- Supply (Costs)
34
What curve is split in consumption externalities
- Demand (benefits)
35
Where does the nose of the welfare triangle always point
- Towards the social optimum
36
Example of positive production externalities
- Bakery- smells nice to outsiders
37
Examples of positive consumption externalities
- Vaccinations- protects health of others by reducing speed of virus
38
Examples of negative consumption externality
- Smoking- second hand smoke has health risks to others
39
Examples of negative production externality
- Production of toys in workshops- produces air pollution from factory
40
Dermit good case study example
- Smoking
41
Facts about smoking
- Every year, 200,000 children between 11-15 start smoking
- 1 in 5 adults smoke
- Diseases related to smoking are biggest killers in UK
- For lifetime smokers, half can expect to die prematurely as a result
42
What are the private costs of smoking
- Health issues- lung cancer, heart problems- premature death
- Increased risks of miscarriage, premature birth or stillbirth during pregnancy
43
External costs of smoking
- Pressure on NHS- cost if caring for patients
- Second hand smoke- cause health risks for people who around smokers
- Children born to parents who smoked during pregnancy much higher risk of health issues in their lives
44
Govt response to combat smoking
- Plain packaging- warns users of risks of smoking- undesirable
- Increased tax on sales
- More advertisement/accessibility of alternatives
45
What is a merit good
- Something that has positive externalities, and people underestimate benefits
46
What is a demerit good
- People underestimate costs, and has negative externalities
47
Why do the government intervene
- To try and move towards max welfare of the population
48
How do governments influence the allocation of resources
- Public expenditure (G)- state provision
- Taxation and subsidies- influence firms/consumer decisions
- Regulation- discourage people from use of demerit goods and vice versa
49
What ways can the govt correct market failure
- Indirect taxation
- Subsidies
- Price controls
- State provision
- Regulation
- Correcting information failure
- Pollution permits
50
What is indirect taxation
- The imposition of a tax leading to increases COP for a firm, leading to a shift in supply curve to the left
- With less quantity supplies, price will increase
51
What is the difference between indirect and direct taxation
- Direct- on an individual or organisation
- Indirect- On a good or service
52
What is the incidence of tax
- The amount that the consumer or producer will pay for the tax
53
Advantages of indirect taxation
- High tax revenues
- Still gives consumer/producer choice
- Internalises the externality
54
Disadvantages of indirect taxation
- If price inelastic, demand may not reduce much- eg addiction
- Hard to know correct level of tax
- Regressive taxation- more effect on low income households
- Impacts UK firms' international competitiveness
55
What is the incidence of the indirect tax if demand is inelastic
- Incidence of tax is greater of consumer
56
What is the effect of indirect tax if demand is price inelastic
- The incidence of tax is greater for the producer
57
What is the effect of indirect tax if supply is inelastic
- The incidence of tax is greater for the producer
58
What is the effect of indirect taxation if the supply is price elastic
- The incidence of tax is greater for consumer
59
What is a subsidy
- Payment made to producers to encourage increased production of a good or service
60
What is the impact of a subsidy
- Decreases COP for a firm, leading to a right shift in the supply curve
- This increases quantity supplied, decreasing price
61
Advantages of subsidies
- Increase consumption of merit goods
- Lower prices so more affordable for lower incomes (progressive)
62
Disadvantages of subsidies
- Difficult to judge size of externality
- Opportunity cost
- Firms become reliant
- Seen as artificial trade protection
- If price inelastic, consumption may not change
63
What is a price control
- When the government set a maximum or minimum price for a good or service
64
What does imposing a minimum (floor) price do
- Leads to excess supply, as firms will wish to supply more at a higher price
65
Advantages of minimum prices
- Producers get a minimum guaranteed price
- Encourage production of essentials
- Excess supply can be stored
66
Disadvantages of minimum price
- Consumers may pay a higher price
- Encourages over production
- Opportunity cost of gov expenditure
- May encourage consumers to seek cheape, harmful alternatives- black market
67
What does imposing a maximum (ceiling) price do
- Lead to excess demand as consumer will wish to demand more at a lower price
- Prevents consumer from being exploited
68
Advantages of maximum price
- Allow people less well off to afford necessities
- Lessens monopoly power, reducing exploitation of consumers
69
Disadvantages of maximum prices
- May create excess demand- so some unable to access good/service- Queues, shortages and waiting lists
- Black markets may appear
70
What is state provisions
- When the govt (or state) intervenes in the market to supply a good or service
71
When will the govt provide a good
If they believe it to be a:
- Merit good- healthcare, education
- Public good- defence and infrastructure
72
Advantages of state provision
- Individuals don't have to worry about costs at point of consumption
- Could improve equality
- Can match govt objectives
73
Disadvantages of state provision
- Opportunity cost
- Govt may not have sufficient information
74
What is regulation
- Undertaken by the government to create competitive markets to protect consumers from exploitation
75
Advantages of regulation
- Helps consumers to make better decisions
- If effective, leads to greater choice and lower prices
76
Disadvantages of regulation
- Interference from the 'nanny state'- fear of govt being too controlling
- Suppliers may find a way around this
77
What is information failure
When consumers consume too much/too little of a good due to lack of adequate information about the good
78
Methods of correcting information failure
- Clearer labelling
- Campaigns to raise awareness
- Health warnings
- League tables (ranking)
- More open reporting
79
Advantages of correcting information failure
- Less costly solution
- Targeted at specific individuals
80
Disadvantages of correcting information failure
- Does government know best? could be argued people should be able to make their own decisions
81
Issue with lack of clearly defined property rights
- Often leads to environmental market failure
82
What can extending property rights do to combat market failure
- Encourage greater valuing of the environment as a resource
83
Advantages of extending property rights
- Uses market mechanism to ensure efficient use of resources
- Takes away pressure from the government to assess the pollution
- Greater likelihood the property/resources will be managed carefully- future availability
- Property owners can charge polluting firms
84
Disadvantages with extending property rights
- Difficult for a govt to do this
- Difficult to trace source of environmental damage
- Legal costs to prosecute a polluter may stop victims from taking action
85
What are pollution permits
- Giving firms a legal right to pollute a certain amount
- Produce incentive for firms to reduce pollution and therefore the externalities associated
86
How is a market for pollution permits created
- Firms that use less pollution than permitted it can sell it to firms who use more
87
Advantages of pollution permits
- Incentivises firms to reduce pollution levels
- Increases govt revenue
- Govt can gradually increase cost or decrease supply over time so it is cheaper for firms to switch to renewable sources
88
Disadvantages of pollution permits
- Difficult to know correct number to give out
- Difficult to measure pollution levels, let alone who is responsible
- Admin costs
- Richer nations can just buy permits from poorer ones- shifts not reduces
- Firms can lie about how much they produce
89
What is the nanny state concept
- When the government is criticised for being overprotective/controlling
- acting like a nanny who is looking after children in care
90
What is government failure
- When intervention to correct market failure (by a government) leads to a net welfare loss in society
91
What are market distortions
- Reasons why market function doesn't lead to equilibrium
92
What is inadequate information (Gov failure)
- Governments not possessing complete information, and so making a decision without knowing all the points to consider
93
Example of inadequate information as a reason for govt failure
- Decision to change tax on diesel vs petrol cars
94
Conflicting objectives as a reason for market failure
- Governments facing an opportunity cost with their decisions
- Making a decision to remove one market failure may hinder another of their objectives, such as growth
95
Examples of conflicting objectives
- Whether to allow fracking in uk- Creates jobs, increases X, however environmental impacts
96
Administrative costs as a form of govt failure
- The cost of resolving the market failure may be more than the welfare benefit gained from correcting failure
97
Examples of administrative costs as a source of govt failure
- Winter fuel allowance for all pensioners vs a means tested payment- finding out which pensioners actually need it and which don't may cost more than actually paying them all
98
Unintended consequences as govt failure
- The reality of a policy, even with lots of info, may create unforeseen problems
99
Examples of unintended consequences as a source of govt failure
- Govt levy to increase apprenticeships actually reduced the number in the scheme due to too many restrictions- made it hard for businesses- 'structure and implementation act as a barrier'
- Down by 31% since prev year
100
Politicians maximising own welfare as a source of govt failure
- Governments may sacrifice the population's welfare in order for political gain
- Eg keeping open an NHS hospital in a marginal constituency rather than making nationwide decisions about care
