Pack 4: Market failure and government intervention

Question 1

What is market failure?

Answer 1

Price mechanism failing to deliver efficiency, results in misallocation of resources

Question 2

What are the types of market failure?

Answer 2

~Externalities
~Under-provision of public goods
~Geographical/occupational immobility of labour
~Monopoly power
~Unstable commodity markets
~Inequality

Question 3

What are private costs?

Answer 3

Direct cost to producer/consumer. Cost internal to exchange, taken into account by price mechanism

Question 4

What are private benefits?

Answer 4

Direct benefit to producer/consumer. Internal to exchange, taken into account by price mechanism

Question 5

What is a negative externality?

Answer 5

Negative third party effects. External to exchange, ignored by price mechanism

Question 6

What are positive externalities?

Answer 6

Positive third party effects. External to exchange, ignored by price mechanism

Question 7

What are social costs?

Answer 7

Private costs + external costs

Question 8

What are social benefits?

Answer 8

Private benefits + external benefits

Question 9

When is government intervention necessary?

Answer 9

When there is over-production and under-consumption to solve market failure

Question 10

What are public goods?

Answer 10

Good which has both non-rivalry and non-excludability characteristics, e.g. street lights

Question 11

What are private goods?

Answer 11

Good which has both rival and excludable characteristics, e.g. an apple

Question 12

What is the free rider problem?

Answer 12

Once public good provided, impossible to prevent those who haven’t paid for it consuming it

Question 13

What is imperfect information?

Answer 13

When economic agents lack all information to make informed choices

Question 14

What is symmetric information?

Answer 14

Situation where all parties have the same amount of information

Question 15

What is asymmetric information?

Answer 15

Situation where one party has more information than another

Question 16

What can governments do to provide information to allow consumers and producers to make informed choices?

Answer 16

~Health campaigns
~information at point of sale, e.g. calories on food
~provision of consumer advice

Question 17

What are the information gaps in healthcare?

Answer 17

~patient exploitation
~Medical conditions not diagnosed
~External benefits ignored

Question 18

What are the information gaps in insurance?

Answer 18

~Lack of care by those insured
~Under-provision

Question 19

What are the information gaps in education?

Answer 19

~Under-consumption
~Problems of choosing correct schooling

Question 20

What are the information gaps with pensions?

Answer 20

~Underinvestment into pension funds

Question 21

What are the information gaps with tobacco and alcohol?

Answer 21

~Over-consumption, external costs ignored

Question 22

What is indirect taxation?

Answer 22

Charge levied on goods/services by government, increases producers costs, reducing supply

Question 23

What are the limitations of indirect taxation?

Answer 23

~Hard to set right tax level
~Less effective when demand price inelastic
~impact on low income consumers
~Negative business impact
~Cost of collection
~Secondary markets

Question 24

What is a subsidy?

Answer 24

Sum of money paid by governments to producer to encourage production and reduce price by reducing production costs

Question 25

What are the limitations of subsidies?

Answer 25

~Difficult to set at right level ~Cost of subsidy ~Impact of efficiency ~Change of behaviour?

Question 26

What is provision of information?

Answer 26

Information provided to uniformed party to allow better decisions

Question 27

What is regulation?

Answer 27

Rules, laws and restrictions put in place by government

Question 28

What is state provision?

Answer 28

When government provides goods/services funded via taxation/borrowing

Question 29

What are tradable permit schemes?

Answer 29

Scheme where limit placed on carbon emissions through issue of permits. Can be bought, sold, fines imposed if limit exceeded without buying permits

Question 30

What are the benefits of the price mechanism?

Answer 30

Work with price mechanism as an incentive for the most efficient firms to reduce pollution, internalising the negative externality

Question 31

What are the limitations of tradable pollution permits?

Answer 31

~Will right number of permits be issued? ~Volatility of price of permits ~Impact on businesses ~Equity issues ~Cost of running scheme

Question 32

What is maximum price?

Answer 32

Price set by Government which good/service cannot rise above

Question 33

What are the benefits of a maximum price?

Answer 33

Improve consumer welfare due to providing lower price than free market equilibrium

Question 34

What are the limitations of maximum prices at solving market failure?

Answer 34

~Shortages on the market ~Possible secondary markets ~Impact on businesses ~Impact depends on max. price ~Impact depends on PED/PES

Question 35

What is a minimum price scheme?

Answer 35

Price set by government which a good/service cannot fall below

Question 36

What are the benefits on minimum prices?

Answer 36

Protect producers incomes, govn. often buy up excess supply (farming)

Question 37

What are the limitations of min. prices?

Answer 37

~Impact on consumer welfare + inequality ~Issues of efficiency ~Issues when governments guarantee to buy excess supply (opportunity cost) ~Impact depends on min. price set ~Impact depends on PED/PES

Question 38

What is a buffer stock scheme?

Answer 38

System of agency intervention to buy/sell a commodity to reduce price fluctuations and meet target price (e.g. max./min price)

Question 39

how does a buffer stock scheme help?

Answer 39

Govn buys when high supply (good harvest) lower price and sells when supply low (bad harvest) higher prices. Solves issue of unstable commodity markets

Question 40

What are the limitations of buffer stock schemes?

Answer 40

~Cost of scheme ~Historic collapse of buffer stock schemes ~Less effective for perishable products ~Co-ordination issues

Question 41

What is government failure?

Answer 41

When governments act to deal with market failures but in the process create further distortions/inefficiencies and a net welfare loss

Question 42

What are the key causes of government failure?

Answer 42

~Distortion of price signals ~Unintended consequences ~Excessive administration costs ~Information gaps