The Market Failure

Question 1

What is market failure?

Answer 1

Market failure is a situation where there is a misallocation of resources when the markets are left to the price mechanism with no government intervention.

Question 2

Define allocative efficiency

Answer 2

Allocative efficiency is the optimal allocation of resources from society’s point of view, producers sell what consumers want.

Question 3

What are three main types of market failure?

Answer 3

Externalities, under-provision of merit goods or over-provision of demerit goods and information gaps.

Question 4

How does price mechanism work in the free market?

Answer 4

The price mechanism in the free market determines the allocation of scarce resources through the interaction of demand and supply.

Question 5

What is a positive externality?

Answer 5

Positive externality is an external benefit, which is a positive third party spill-over effect on individuals not involved in the economic transaction.

Question 6

Define negative externality.

Answer 6

Negative externality is an external cost which is a negative third party spill-over effect on individuals not involved in the economic transaction.

Question 7

What is a public good?

Answer 7

A good that is beneficial to society, but would not be provided in a free market

Question 8

What is asymmetric information?

Answer 8

When buyers and sellers have different levels of information about good or service.

Question 9

Social costs =

Answer 9

Private costs + External Costs

Question 10

Define external benefit

Answer 10

Positive externality

Question 11

What is a private cost?

Answer 11

A private cost is what producers pay to produce a good or service and what consumers pay to purchase a good service.

Question 12

What is marginal private cost? (MPC)

Answer 12

Marginal private cost is the cost of producing the next additional unit of a good/service.

Question 13

How is marginal social benefit (MSB) related to marginal private benefit (MPB)?

Answer 13

Marginal social benefit is assumed to be equal to marginal private benefit when focusing on the producer side of the market.

Question 14

What does over-provision mean?

Answer 14

Over provision means the free market produces more of a good or service than socially optimal due to negative externalities e.g. drugs

Question 15

What is under-consumption?

Answer 15

Under consumption means that consumers consume less of a good that is socially optimum due to underestimation of positive externalities e.g. education

Question 16

What is welfare loss triangle?

Answer 16

The welfare loss triangle represents the loss of society due to over provision or under provision of goods and services.

Question 17

How does government intervention address externalities?

Answer 17

Taxes, subsidies, legislation and regulations.

Question 18

What is a merit good?

Answer 18

A merit good is a good that has positive externalities in consumption and is under consumed in a free market.

Question 19

What is a private good?

Answer 19

A private good is a good that the firm produces to generate profits and consumers consume to gain utility, as it is excludable and rivalrous

Question 20

Define non-excludability

Answer 20

Non-excludability is the inability to prevent non-paying consumers from accessing a good or service.

Question 21

Define non-rivalry

Answer 21

Non-rivalry means that one persons consumption of good does not reduce its availability to others.

Question 22

Why do private firms not provide public goods?

Answer 22

Private firms do not provide public goods because they cannot generate profits due to non-excludability and non-rivalry.

Question 23

What is a free rider problem?

Answer 23

A situation where people can benefit from a good or service without paying for it.

Question 24

How does the free Rider problem affect public goods?

Answer 24

Leads to under provision or no provision of public goods in a free market.

Question 25

How does government typically fund public goods?

Answer 25

Through taxation

Question 26

How do public goods differ from merit goods?

Answer 26

Public goods differ from merit goods in that private firms will not provide public goods at all, while merit goods are provided by private firms but under consumed.

Question 27

How do information gaps affect market outcomes?

Answer 27

Information gaps to start socially optimal prices and quantities in markets, resulting in other provision or under provision of goods and services.

Question 28

What is adverse selection?

Answer 28

Is a market outcome where buyers or sellers use private information to their advantage, leading to inefficient outcomes.

Question 29

Define moral hazard

Answer 29

Moral hazard is a situation where one party takes more risks because another party of beers is the cost of those risks.

Question 30

How can asymmetric information lead to market failure?

Answer 30

By causing inefficient allocation of resources and sub-optimal market outcomes

Question 31

How do information gaps affect the quality of goods in market?

Answer 31

They can lead to a decrease in overall quality of goods in the market as sellers may have an incentive to offer lower quality product.

Question 32

What role can a government play in addressing information gaps?

Answer 32

Implementing regulations, requiring disclosures or providing information directly to consumers.

Question 33

How much information gaps affect the pricing of goods?

Answer 33

Information gaps might lead to mispricing of goods, as buyers may not have accurate information about the true value or quality of product.