Microeconomics Topic 5 YR1 Flashcards
(46 cards)
What is the market mechanism?
The process by which resources are allocated in a market economy through the interaction of demand and supply, also known as the price mechanism.
What are the three main functions of the price mechanism?
Signaling function, incentive function, Rationing function.
What is the signaling function of the price mechanism?
Prices rise or fall to signal to producers and consumers where resources are needed.
What is an example of the signaling function?
An increase in the price of oil signals higher demand or reduced supply, encouraging exploration or conservation.
What is the incentive function of the price mechanism?
Changes in prices create incentives for economic agents to alter their behavior.
What is an example of the incentive function?
Rising wages in high-demand professions like software engineering incentivize workers to acquire relevant skills.
What is the rationing function of the price mechanism?
Limited resources are rationed to those who value them most, as indicated by their willingness to pay.
What is an example of the rationing function?
Scarce housing in urban areas is rationed through higher rates.
What are the strengths of the market mechanism?
Efficient allocation of resources, encourages innovation and competition, provides incentives for efficiency.
What are the limitations of the market mechanism?
Can lead to inequality, fails to account for externalities, public goods, and prone to market failures.
What is market failure?
Market failure occurs when the free market allocates resources inefficiently, leading to a loss of economic and social welfare.
What are the main types of market failure?
Public goods, externalities, information gaps, monopoly power, and immobility of factors of production.
What are the characteristics of public goods?
Non-excludable and non-rivalrous
What is the free-rider problem?
The free rider problem occurs when individuals benefit from public goods without paying for them, leading to under-provision in free markets.
What is an example of a public good?
National defense or street lighting.
What are negative externalities?
Negative externalities are costs imposed on third parties, such as pollution from factories, that lead to market failure.
What is an example of a negative externality?
Pollution caused by manufacturing.
What diagram represents negative externalities?
A diagram showing overproduction where Marginal social cost (MSC) > Marginal private cost (MPC)
What are positive externalities?
Positive externalities are benefits provided to third parties, such as planting trees that improve air quality, which lead to under-provision in free markets.
What is an example of a positive externality?
Vaccinations, which provide herd immunity.
What diagram represents positive externalities?
A diagram showing underproduction where Marginal Social Benefit (MSB) > Marginal Private Benefit (MPB).
What is imperfect information?
When buyers or sellers lack full information to make rational decisions.
What is an example of imperfect information?
Consumers not knowing the long-term health risks of sugary drinks.
What is monopoly power?
Monopoly power exists when a single firm dominates a market, allowing it to control prices and supply, leading to inefficiency. It typically results in higher prices and reduced choice for consumers.
