The market mechanism, market failure + govt intervention in markets

Question 1

Price function

Answer 1

Allocate scarce resources
- Signalling (price changes)
- Incentive (increase output/consumption)
- Rationing (change £ to correct surplus)
- Allocation (allocate efficiently)

Question 2

Price mechanism

Answer 2

• £ changes (all ineff)
• D surplus = price rises
• S surplus = price falls
• Pros = meet needs, all eff, self-regulating, choice
• Cons = inequality, socially inoptimum production, lack public goods, unemp

Question 3

Resource allocation

Answer 3

• Price mechanism
• Above price = consumers value higher than £ (allocate)
• Below price = consumers value lower than £ (don’t allocate)

Question 4

Market failure

Answer 4

Production not economically eff
- Complete = missing market
- Partial = functions at wrong quantity
- Consequences = externalities, info gaps, irrationality, inequality, volatility, inefficiency

Question 5

Govt intervention in market failure

Answer 5

• Indirect tax
• Subsidies
• Regulations
• Bans
• Provision
• Price controls
• Competition/ redistributive policies

Question 6

Types of goods

Answer 6

• Public = non-excludable (free rider problem), non rival(not deplete) = (prevent market failure, equity, efficiency, cost, corruption)
• Private = excludable (prevent access), rival (law dim mar utility)
• Quasi-public = public but can be privatised (hotel beaches, toll roads)

Question 7

Externalities

Answer 7

• +ve = external benefit from C/P of good (underC/P)
  –> Policies = subs, prov, leg, reg
• -ve = external cost from C/P of good (over C/P)
  –> Policies = indirect tax, tradable pollution permits, bans, leg, reg

Question 8

Merit/demerit goods

Answer 8

• Merit = underC/P, benefits not understood, subs/provision (healthcare, education)
• Demerit = overC/P, costs not understood, tax/reg (tobacco, gambling)

Question 9

Info gaps/failure

Answer 9

• Info gaps = lack of info leads to misall/market failure
• Info failure = lack of asymmetric info lead to inefficient C/P (tanning beds, 2nd hand goods, insurance)

Question 10

Factor mobility

Answer 10

• Geographical = 1 place to another (willingness/ability to move)
• Occupational = 1 role to another (transferrable skills)

Question 11

Competition policy

Answer 11

• Govt reg on markets/mon
• Aims = manage mon power, reduce barriers, recommend policies, maintain comp, protect consumer interests

Question 12

Competition policy agencies

Answer 12

• OFT (Office of Fair Trading) = investigate mon power, refer mergers to CC
• CC (Competition Commission) = investigate mergers/industries that threaten comp
• CMA (Competition and Markets Authority) = investigate anti-comp practices, ensure contestability, prevent consumer exploitation

Question 13

Types of industry ownership

Answer 13

• Priv + prof (sole trader, partner, Ltd, Plc)
• Priv + non-prof (charities, co-ops)
• Pub + prof (nationalised: British Steel)
• Pub + non-prof (public services: NHS)

Question 14

Privatisation

Answer 14

• Selling assets to priv industry
• Pros = eff (profit incentive), lack politics, LR view (budget/elections), shareholder pressure, comp, govt rev, market discipline, raise capital
• Cons = natural mon, pub goods, govt lose dividends, reg issues, industry fragmentation, SR view (shareholders), lost EoS, economic leakage (FDI)
• Depends on (industry nature, reg, contestability, comp, incentive)

Question 15

Regulation/deregulation

Answer 15

• Reg types = bans, limits, caps, enforcement, comp action, punish, reg
• Reg pros = standards, innovation, comp, info prov, protect C’s
• Reg cons = cost (govt + firms), comp disincentive, less I, govt failure, reg capture
• Dereg pros = choice, eff, productivity
• Dereg cons = mon power, oligopolies, resource depletion, prices (C’s)

Question 16

Indirect tax

Answer 16

• Tax on producers of demerit goods
• Dif elasticities shift burden
• Pros = correct market failure, deter C, govt rev, tackle climate
• Cons = regressive, complex, costs, tax evasion, govt failure

Question 17

Subsidies

Answer 17

• Payment to producers of merit goods to decrease costs/prices
• Dif elasticities shift benefit
• Pros = correct market failure, increase C, encourage I/innovation/comp, comp X, env, support low Y
• Cons = govt oppt cost, over-reliance, lower eff/prod incentive, may not lower price (benefit), govt failure, fraud/corruption

Question 18

Max pricing (price ceiling)

Answer 18

• Pros = make necessities affordable, increase C, prevent exploitation
• Cons = D surplus, disequilibrium, lose price rationing function, govt failire
• Problems = excess D, supply disincentive, oppt cost (sub, prov, redistribution)
• Eg. rent control, energy price cap

Question 19

Min pricing (price floor)

Answer 19

• Pros = support Y/jobs, encourage I/innovation, lower C of demerit goods
• Cons = S surplus, disequilibrium, lost signalling/incentivising function, govt cost/failure
• Problems = excess S, unemployment, oppt cost (indirect tax, info prov)
• Eg. NMW, min price for alcohol, agricultural support

Question 20

Govt failure

Answer 20

• Market intervention causes unintended consequences (may worsen misallocation)
• Causes = political self-interest, short term policies, conflicting objs
• Consequences = inequalities, higher costs, negative externalities