Market Failure

Question 1

What is market failure ?

Answer 1

Occurs when price mechanism fails to allocate scarce resources efficiently

• Exists when competitive outcome of markets isn’t satisfactory from the point of view of society.

Question 2

Complete and partial market failure

Answer 2

Complete market failure occurs when the market simply doesn’t supply products at all

• Partial market failure occurs when the market does function but produces either the wrong quantity or wrong price of a product

Question 3

Markets fall for a number of reasons

Answer 3

Society can lose out as a result of market failure,
o classic example is externalities production and consumption;
▪ Negative externalities, pollution from factory output tends to be oversupplied.

▪ Positive externalities goods and services could be under consumed (healthcare and education

• Imperfect information or information failure
  o Merit goods are under-produced while demerit goods are over-produced or over-consumed
• Monopoly power – when a firm controls the market and can set higher prices
• Agriculture – often subject to market failure – unpredictable prices and externalities

Question 4

Key terms in market failure

Answer 4

Externalities: These occur when a third party is affected by the decisions and actions of others.

• Social benefit: the total benefit to society =
Private Marginal Benefit (PMB) + External Marginal Benefit (XMB)

• Social Cost: is the total cost to society =
Private Marginal Cost (PMC) + External Marginal Cost (XMC

• Social Efficiency: This occurs when resources are utilised in the most efficient way. This will occur at an output where social marginal cost (SMC) = Social Marginal Benefit. (SMB)

Question 5

Overcoming market failure

Answer 5

Tax on negative externalities– e.g. Petrol tax

• Laws & regulations– Simple and effective ways to regulate demerit goods, like a ban on smoking advertising.