Section 5: Market Failure

Question 1

When does a market fail

Answer 1

When the price mechanism fails to allocate scarce resources efficiently and society suffers as a result

Question 2

What is an externality

Answer 2

The effects that producing or consuming a good or service has on people who aren’t involved in making, buying or selling and consumption of the good or service

Question 3

What can happen if externalities are ignored

Answer 3

Market failure

Question 4

What is a private cost

Answer 4

The cost of doing something to either a consumer or a firm

Question 5

What is social cost

Answer 5

External cost plus private cost

Question 6

What is marginal private cost

Answer 6

The cost of producing the last unit of a good

Question 7

What is marginal social cost

Answer 7

The marginal private cost plus the external cost

Question 8

How can you see the external cost on a diagram with Price, costs, benefits being the y-axis and quantity being the x-axis

Answer 8

The gap between the marginal social cost and the marginal private cost is external cost

Question 9

If the marginal social cost curve is parallel to the marginal private cost then what does that tell you about the external cost

Answer 9

The external cost is constant

Question 10

What is marginal private benefit

Answer 10

The benefit to someone of consuming the last unit of a good

Question 11

What is marginal social benefit

Answer 11

The marginal private benefit plus the external benefit

Question 12

What is the difference between the marginal private benefit curve and the marginal social benefit curve

Answer 12

The positive externalities

Question 13

In a free market where does equilibrium occur with relation to the marginal private cost and the marginal private benefit and give 2 reasons why

Answer 13

Equilibrium occurs when the MPC=MPB
This is because in a free market consumers and producers only consider their private costs and private benefits - as a result the MPC curve can be seen as the supply curve of a good or service and the MPB curve can be seen as the demand curve
So equilibrium occurs when MPC=MPB

Question 14

In a free market at what point is the socially optimal point

Answer 14

Where MSC=MSB

Question 15

What happens to the production and pricing of a good if only the private costs are considered

Answer 15

Leads to overproduction and underpricing

Question 16

What does the triangle where the MSC and MPC curves meet the MPC=MSC represent

Answer 16

The welfare loss or the welfare gain depending on the direction of the curves involved

Question 17

What is welfare loss

Answer 17

The loss to society caused by ignoring externalities

Question 18

What happens to the consumption and pricing of a good if only private benefits are considered

Answer 18

Leads to underconsumption and underpricing of this good

Question 19

What is welfare gain

Answer 19

The impact of a government policy or decision taking into account the gains minus any losses

Question 20

What are public goods

Answer 20

Goods that can be consumed collectively

Question 21

What are the 2 main characteristics of public goods

Answer 21

Non-exludability - people cannot be stopped from consuming the good even if they haven’t paid for it
Non-rivalry/non-diminishability - one person benefiting from the good doesn’t stop others benefiting - this means that public goods have zero marginal cost because there’s no additional cost to extending the good to one more person

Question 22

What are the 2 types of public goods

Answer 22

Pure public goods and non-pure or quasi public goods

Question 23

What factor can change a good that once had the characteristics of a public good into a private good

Answer 23

New technology

Question 24

Describe the provision of public goods

Answer 24

Public goods are under-provided by the free market

Question 25

What is the free rider problem

Answer 25

Once a public good is provided it's impossible to stop someone from benefiting from it, even if they haven't paid towards it

Question 26

Why are public goods underprovided by the free market (2 aspects)

Answer 26

Producers overvalue the benefit of a public good to raise the price and consumers do the opposite The price mechanism doesn't work if the free rider problem exists

Question 27

What is the tragedy of the commons

Answer 27

The idea that people acting in their own best interest will overuse a common resource without considering that this will lead to the depeletion or degradation of that resource

Question 28

What is symmetric information

Answer 28

Everyone has equal and perfect knowledge

Question 29

What type of information is assumed in a competitive market

Answer 29

It's assumed that there's perfect information - buyers and sellers are assumed to have full knowledge regarding prices, costs, benefits and availability of products

Question 30

What does symmetric information lead to if we assume the buyers and sellers are rational

Answer 30

Efficient allocation of resources in and between markets will take place

Question 31

What is asymmetric information

Answer 31

When the buyer or seller has more information than the other

Question 32

What are the 2 reasons for asymmetric information

Answer 32

Providers may lack information because they provide an unpredictable service Moral hazard - This happens when people take risks because they won't suffer the consequences themselves if things go wrong

Question 33

If there is imperfect information how will this affect the consumption of merit and demerit goods

Answer 33

This will lead to merit goods being underconsumed and demerit goods being overconsumed

Question 34

Give 4 reasons why merit goods are consumed less when there is imperfect information

Answer 34

Consumers may not know the full benefit of a merit good Consumers may lack the information to decide which good or service is right for them Consumers may not have the information on how harmful a demerit good is Advertising for a demerit good may withhold or ignore any health dangers

Question 35

Give a reason why demerit goods are consumed more when there is imperfect information

Answer 35

Information on a good may be too complex to understand