Market failure

Question 1

what does social cost equal to

Answer 1

private cost + external cost

Question 2

positive externalities: difference between under-consumption and under-production

Answer 2

1. under-consumption is with merit good, when MSB > MPB

2. under-production is with renewable energy, when MPC > MSC

Question 3

with externalities, what is the ‘supply’ curve and what is the ‘demand’ curve

Answer 3

cost is supply and benefit is demand

Question 4

negative externalities: difference between over production and over-consumption

Answer 4

1. over-production e.g. factory pollution - MSC > MPC

2. over-consumption e.g. fast food MSB < MPB

Question 5

define an externality

Answer 5

element of transaction imposed upon an uncompensated third party

Question 6

how do you combat negative production externalities?

Answer 6

taxes

Question 7

how do you combat positive production externalities?

Answer 7

subsidies and grants

Question 8

how do you combat positive consumption externalities?

Answer 8

education

Question 9

how do you combat negative consumption externalities?

Answer 9

tax, information, regulation

Question 10

name a key reason for under-provision of public goods

Answer 10

the free rider problem - there is a large incentive for individuals not to pay for the good because someone else might, which is why it may be left under provided if left to free market allocation

Question 11

key reason for under/over consumption of merit/demerit goods

Answer 11

information failure

Question 12

name reasons for market failure

Answer 12

1. Factor immobility
2. inequality
3. Information asymmetry
4. Lack of competition
5. Under-Provision of public goods
6. demerit and merit goods

Question 13

what is ad valorem tax

Answer 13

a tax levied as a percentage of the value of the good/service e.g. 20% VAT

Question 14

name 3 problems with imposing indirect taxes

Answer 14

1. difficult to target (due to information failure - not knowing extent of market failure)
2. conflict of raising revenue and correcting market failure
3. taxes are unpopular e.g. in 1990s UK had to abandon plan to raise VAT on gas

Question 15

example of failure to remove subsidies

Answer 15

attempts to remove subsidies on food or fuel in Iran have caused riots

Question 16

explain how buffer stock schemes work

Answer 16

this is done to stabilise price of commodities;
if min price is set, and free market price threatens to go below this, the scheme will buy commodity, increasing demand and raising prices
if max price set, then sell, increase supply, raise price

Question 17

name two unintended consequences of CAP

Answer 17

1. in 70s and 80s most of EU budget was spent on CAP, and EU consumers had paid much higher prices than they would otherwise
2. Depressed world prices - EU bought up certain products at min price and sold below this at world markets –> farmers in rich countries suffered for lower prices for their produce, as well as producers in developing countries who wouldn’t compete

Question 18

name types of government failure

Answer 18

1. Distortion of price signals (labour market)
2. Unintended consequences (CAP)
3. Admin costs
4. Information gaps
5. Conflicting objectives
6. Politics

Question 19

name two phenomenons that happen politics which ensure government failure

Answer 19

1. public choice theory - politicians act to maximise their own utility, regardless of whether it improves citizen welfare e.g. for re-election
2. rent-seeking behaviour - those in power manipulate distribution of resources to benefit themselves e.g. receiving bribes from companies to ensure they win govt contract