Theme 1 - Markets and Market Failure [INCOMPLETE - NO GOV INTERVENTION] Flashcards
(170 cards)
1
Q
Why do economists develop models
A
- explain how economy works
- developed by putting forward model, gathering evidence, accepting/challenging/disregarding model
- too many variables which can change so assumptions are made
2
Q
Why do economists make assumptions when developing models
A
- too many variables which can change
- allows them to simplify problem
- ceteris paribus = all other things remaining equal
3
Q
What is a positive statement
A
- objective and made without any obvious value judgements
- can be tested to be proven/disproven
- expressed in the form of a hypothesis that can be analysed and evaluated
4
Q
What is a normative statement
A
- subjective and based on opinion
- cannot be proven/disproven
5
Q
What are value judgments
A
- influence economic decision making and policy
6
Q
What is the economic problem
A
- stems from the basic problem of scarcity
- how to use the available scarce resources to satisfy people’s infinite needs and wants as effectively as possible
7
Q
What are the questions that economics sets out to investigate
A
- what to produce
- how to produce it
- who to produce it for
8
Q
What are economic agents and who are they
A
- groups that participate in the economy
- producers, consumers and the government
9
Q
What do the economic agents do
A
- producers create goods and services
- consumers buy goods and services made by firms
- the government sets out the rules that other economic agents must follows, also produces some goods and services like infrastructure and healthcare
10
Q
What is a renewable resource
A
- resource of economic value that can be replenished or replaced on a level equal to consumption
- as long as rate of consumption is less than or equal to rate of replenishment, stock will not decrease
11
Q
What is a non-renewable resource
A
- resource of economic value which cannot be readily replaced by natural means on a level equal to consumption
12
Q
What is opportunity cost
A
- the value of the next best alternative foregone
- same resource cannot be used to produce different goods at the same time so decisions have to be made on where to use them
13
Q
How do the economic agents make decisions for opportunity cost
A
- consumers choose how to use their limited income based on what gives them the greatest level of satisfaction
- producers choose what to do with their limited resources and decisions are based on profit
- the government decides where to spend their limited tax revenue based on what maximises social welfare
14
Q
What are the factors of production
A
- capital
- enterprise
- land
- labour
15
Q
What is capital
A
- goods used to make other goods and services (machinery)
16
Q
What is enterprise
A
- willingness of people in business to take risks to make a profit
17
Q
What is land
A
- natural resources which can be used to make goods and services
18
Q
What is labour
A
- all the work done by humans in production
19
Q
What is a possibility production frontier (PPF)
A
- shows maximum possible combinations of capital and consumer goods that economy can produce with its current resources and technology
- no indication which combination is best
20
Q
When is an economy efficient
A
- economic efficiency is achieved when resources are used for their best use
- at all points on PPF curve, resources are allocated efficiently
21
Q
What does a movement on the PPF curve show
A
- a change in the combination of goods produces
22
Q
What does a shift on the PPF curve show
A
- change in productive potential of the economy
23
Q
What are consumer goods
A
- goods that are demanded and bought by households and individuals to increase satisfaction
24
Q
What are capital goods
A
- goods that are produced in order aid the production of consumer goods
25
What is specialisation
- production of a limited range of goods by a company/individual/country
26
What is division of labour
- when labour becomes specialised in a particular part of the production process
27
What is productivity
- output produced over inputs used
28
Who is Adam Smith and what did he believe in
- economist who focused on specialisation and division of labour
- stated how they can increase labour productivity, allowing firms to increase efficiency and lower production costs
29
What does increased productivity lead to
- higher output and quality
- higher living standards
- more efficient use of resources
30
What are the advantages of specialisation and division of labour in production
- DoL allows labour productivity to be increased so workers are quicker, better and more efficient
- lead to higher quality of goods and services
- more cost effective
- time is not wasted
- workers only need to be trained to do one specific task, which saves time and money
31
What are the disadvantages of specialisation and division of labour in production
- work can become repetitive and boring which leads to poor quality
- reduction in craftsmanship, leading to more of a standardised production
- if one area of production is delayed, all other following areas need to be stopped
- workforce do not have wide industrial training and could suffer from structural unemployment
32
What are the advantages of specialisation and division of labour in trade
- theory of comparative advantage states countries should specialise in producing goods where they have lowest opportunity cost, so they are relatively best at producing. Helps boost economy
33
What are the disadvantages of specialisation and division of labour in trade
- countries may become over-dependent on one particular export, if this fails their economy may collapse => primary product dependency
- other countries specialise in non-renewable resources and these could run out, leading to a huge loss of income
- high interdependence
- more competition to cut costs so wages may fall (not necessarily true)
34
What are the functions of money
- medium of exchange
- measure of value
- store of value
- method of deferred payment
35
How is medium of exchange a function of money
- allows money to be used to buy and sell goods and services and is acceptable everywhere
36
How is measure of value a function of money
- can compare value of two goods
- puts value on labour
37
How is store of value a function of money
- able to keep its value and can be kept for a long time
38
How is method for deferred payment a function of money
- money can allow for debts to be created
- people can therefore pay for things without having money in the present and pay for it later
- relies on money storing its value
39
What can lower costs from specialisation and DoL lead to
- increased investment
- higher wages
- lower prices
- greater chance for new and improved products emerging
40
What are the different types of economies
- free market economy
- mixed economy
- command economy
41
What is the free market economy
- individuals are free to make their own choices and own the factors of production without government interference
- resources are allocated through price mechanism
- consumers make decisions based on satisfaction
- producers makes decisions based on profit
- no economy is completely free as government has to intervene to an extent
42
What did Adam Smith think about the free market economy
- believed in this economy and the laissez-faire approach by governments
- explained how there was an invisible hand in the market which allocated resources to everyone’s advantage
- believed competition in the market caused lower prices and benefits consumer
- did also argue state needs to provide some goods/services (laws, property rights, infrastructure)
43
What did Freidrich Hayek think about the free market economy
- argued state control of economy leads to loss of freedom
- believed poor in free market countries were better than those in command economies as they had freedom
- central planning by governments led to what a small minority wanted being forced on the whole society
- consumers know what they need in their own situation
44
What are the advantages of a free market economy
- system is automatic due to invisible hand
- consumers have freedom of choice (consumer sovereignty)
- high motivation as people know working hard could lead to high potential rewards
- political freedom
- as firms are in competition, they will produce at lowest cost, ensuring productive efficiency
- free market economies have higher growth
45
What are the disadvantages of a free market economy
- higher levels of inequality
- lack of merit goods and little control of demerit goods
- resources could be wasted on unproductive expenses such as advertising
- if competition disappears then there may be monopolies
- problem of externalities
46
What is a command economy
- all factors of production (but labour) is owned by the state and labour is directed by the state
- everyone is working for a common good
- resource allocation carried out by government
- all workers receive save wage and products are standardised
47
What did Karl Marx think about the command economy
- believed in command economy and criticised capitalism
- believed capitalist’s profit came from exploiting labour
- wanted to remove difference between incomes of owners and workers
- two class system in capitalism (businesses growing by workers getting poorer)
48
What are the advantages of a command economy
- state provides minimum standard of living, less inequality
- less wastage of resources as there is no need for competitive services
- long term planning means industry doesn’t have to keep changing and shifting resources
- standardised products mean they are produced cost effectively
- government (who are motivated by wellbeing of country), decide resource allocation
49
What are the disadvantages of a command economy
- impossible for state to make so many decisions correctly, could lead to over or under supply and a waste of resources
- decision making is slow as there’s many stages and there could be increased bribery and corruption
- less motivation and efficiency as everyone receives same wage so people will know working harder does not increase standard of living
- consumers lose freedom
50
What is a mixed economy
- compromise economy between free market and command
- both free market mechanism and government planning process allocate a significant amount of total resources in a country
51
What is the governments role in a mixed economy
- creating a framework of rules
- supplements and modifies the price system
- redistribute income
- stabilises the economy
52
How does the government create a framework of rules in a mixed economy
- prevent the abuse of monopolies
- protect consumers as they pass a large amount of consumer protection laws
- protect property rights
- ensure safety standards protecting employers and employees
53
How does the government supplement and modify the price system in a mixed economy
- produce public and merit foods and limit production of demerit foods
- government action ensures the consideration of externalities
54
How does the government redistribute income in a mixed economy
- move income from one group of people to another
- use taxes to take money from one group and give the money to the poor
- form of benefits for those out of work or on low incomes
55
How does the government stabilise the economy in a mixed economy
- attempts to manage level of demand in the economy to prevent extremes of too much or too little demand
- do this through fiscal and monetary policies
56
How do consumers make rational decisions
- aim to maximise utility
- utility is the satisfaction gained from consuming a product
- rational consumer is called Homo Economicus, who makes decisions by calculating the utility gained from each decisions and chooses the one which gives most satisfaction
57
How do producers make rational decisions
- aim to maximise profit
- economic theory assumes firms are run for their owners and shareholders and so aim to maximise profit in order to keep shareholders happy
58
How do governments make rational decisions
- aim to maximise social welfare
- voted in by public and work for public so aim to maximise their satisfaction by taking decisions which increase social welfare
59
Why may consumers not behave rationally
- habitual behaviour / consumer inertia
- influence of other people’s behaviour
- consumer weakness at computation
60
What is demand
- the quantity of a good or service purchased at a given price over a given time period
61
How do movements on a demand curve look like
62
What is the difference between a shift and movement on the demand curve
- movement is caused by a change in the price of the good
- shift is caused by a change in any other factor which affects demand
63
What is a contraction in demand
- quantity demanded falls because of an increase in price
64
What is an extension in demand
- quantity demanded rises due to a decrease in price
65
How do shifts on a demand curve look like
66
What are the conditions of demand
- population
- income
- related goods
- advertising
- taste/fashion
- expectations
- seasons
- legislation
67
How does population affect demand
- if population rises, demand increases so curve shifts to the right
- there are more people in the country who would want a good
68
How does income affect demand
- for most goods, if income increases, demand increases and shifts to right as people can afford to buy more of the product
- fall in come then demand decreases and shifts to left
- however, for some goods, increase in income and lead to fall in demand (income elasticity of demand
69
How do related goods affect demand
- if goods are complements or substitutes of each other then a change in price of another good causes a shift in demand curve
- substitutes are goods which are alternatives to each other, so if demand for one increases, demand for the other decreases
- complements are goods which go together so if demand for one increases, demand for the other does as well
- cross elasticity of demand
70
How does advertising affect demand
- if firm carries out a successful advertising campaign, demand is likely to increase
- if competitor firm carries out successful advertising campaign, demand for first firm falls
71
How does taste/fashion affect demand
- if something becomes more fashionable, we expect demand to increase
- if something becomes less fashionable, demand falls
72
How do expectations affect demand
- expectations of what might happen in the future can have a big impact on levels of demand
- if people expect shortage of something or price rises, demand for product increases
- if people expect price falls in future, demand decreases until price falls
73
How do seasons affect demand
- some products will find their demand affected by the weather
- hot summers can increase demand for sun cream and a fall in demand for umbrellas
74
How does government legislation affect demand
- government can implement laws which lead to increases in demand for goods
- demand for car seats increased after the government made it a legal requirement for young children to sit in them
75
What is the law of diminishing marginal utility
- satisfaction derived from consumption of an additional unit of good decreases as more of a good is consumed, ceteris paribus
76
What can the law of diminishing marginal utility help explain
- demand curve sloped downward
- if more of a good is consumed, less satisfaction is derived from good
- means consumers less willing to pay high prices at high quantities since they gain less satisfaction
77
Why does the demand curve slope downward
- inverse relationship between price and quantity, which can be explained by law of diminishing marginal utility
78
How do consumers act rationally
- spending money according to what gives them the greatest level of satisfaction or welfare
79
What is price elasticity of demand (PED)
- responsiveness of demand to a change in the price of a good
80
How can price elasticity of demand (PED) be calculated
Change in quantity demand / change in price
81
What type of elasticity is present at different numerical values
- 1 = unitary elastic
- >1 = relatively elastic
- <1 = relatively inelastic
- ∞ = perfectly elastic
- 0 = perfectly inelastic
82
What factors can influence the price elasticity of demand
- number substitutes
- time
- necessity/luxury
- proportion of income
- addictivenss
83
How does the number of substitutes affect the price elasticity of demand
- if a product has many substitutes, it will be elastic
- an increase in price will lead to consumers buying those substitutes instead
- if product does not have many substitutes, consumers will not have many alternatives so product is inelastic
84
How does time affect the price elasticity of demand
- if consumers have a lot of time, it would be easier to find alternatives so the good is more elastic
- less time means good is inelastic
85
How does the good being a necessity affect the price elasticity of demand
- if the good is a necessity, it will be inelastic as people will still buy it when prices rise
- if good is a luxury then it would be elastic as people would only buy when prices are low
86
How does proportion of income spent affect the price elasticity of demand
- if only a small amount of a person’s income is spent on the good, a significant increase would have a small impact on buying that product
- this would mean the good is inelastic
- if the good previously already took a large proportion of income, another increase would make it elastic
87
How does addictiveness affect price elasticity of demand
- if a product is addictive, people will buy it even if prices rise, making it inelastic
- if a product is not addictive, it would be inelastic
88
How is price elasticity of demand significant
- determines effects of imposition of indirect taxes and subsidies
89
Draw the incidence of tax diagrams for elastic demand
90
Draw the incidence of tax diagrams for inelastic demand
91
How is tax significant for price elasticity of demand
- more elastic lowers incidence of tax on consumer
- means added tax will only slightly increase price for consumer while supplier covers rest
- inelastic demand means majority of tax is pushed onto consumers
- tax would be ineffective at reducing output but government gains higher revenue
92
How are subsidies significant for price elasticity of demand
- elastic demand means consumer sees small fall in price while producer gains extra revenue
- inelastic demand, more the price falls
- elastic demand also means large change in output following subsidy, while inelastic means little change
- therefore subsidies on inelastic goods are ineffective at increasing output
- they are cheaper for the government to impose since output increases by less so government pays subsidy on less goods
93
Explain the diagram for incidence of tax on elasticity
- first diagram shows inelastic demand and curve is steep
- tax leads to small fall in output but large increase in price
- second diagram shows elastic demand as curve is sloping
- output falls significantly and producer burden is high
- diagrams also show revenue generated is higher when demand is inelastic
- shift from S1 to S2 in tax diagram shows raise in cost of production and shifts supply to left
94
Explain the diagram for incidence of subsidy on elasticity
- demand is inelastic => small rise in output but large fall in price with little producer gain
- demand is elastic in second => large rise in output but small fall in price
- show government has to spend more for subsidies on elastic goods
- shift from S1 to S2 on subsidy diagrams decreases cost of production and shifts supply to the right
95
How is revenue and PED linked
- elastic demand curve => decrease in price leads to increase in revenue, and increase in price leads to decrease in revenue
- inelastic demand curve => decrease in price leads to decrease in revenue, and increase in price leads to increase in revenue
- unitary elastic curve => change in price does not affect total revenue
96
What is income elasticity of demand
- YED
- responsiveness of demand to a change in income
97
How do you work out YED
change in quantity demand / change in income
98
What are the different goods in YED
- inferior good => YED<0, rise in income leads to fall in demand for good
- normal good => YED>0, rise in incomes leads to rise in demand for good
- luxury good => YED>1, type of normal good
- goods can be elastic or inelastic
- inelastic goods tend to be necessities
99
What is the significance of YED
- important for businesses to know how their sales will be affected by changes in income of population
- if economy is improving and people’s incomes rise, it is vital a business knows whether this increases sales or not
- may have an impact on type of goods a firm produces
- during times of prosperity, firms might producer more luxury goods and less inferior goods
100
What is cross elasticity of demand
- XED
- responsiveness of demand for one product (A) to the change in price of another product (B)
101
How do you work out XED
Change in quantity demand of A / change in price of B
102
What are the types of goods in XED
- substitutes => XED>0, increase in price of B will increase demand for A
- complementary goods => XED<0, increase in price of A will decrease demand for B
- unrelated goods => XED=0, change in price of B has no impact on A
- size of integer reprints strength of relationship
103
What is the significance of XED
- firms need to be aware of their competition and those producing complementary goods
- need to know how price changes by other firms will impact them so they can take appropriate action
104
What is supply
- quantity of a good or service that firms are willing to sell at a given price over a given time period
105
What causes movements in supply
- change in price of good
- movement down the curve is a contraction => quantity supplied falls due to decrease in price
- movement up the curve is an extension => quantity supplied rises due to increase in price
106
What causes shifts in supply
- change in any of the factors which affect supply
- left shift is a decrease in supply => fewer goods supplied at each and every price
- right shift is an increase in supply => more goods supplied at each and every price
107
What are the conditions of supply
- costs of production
- price of other goods
- weather
- technology
- goals of supplier
- government legislation
- taxes and subsides
- producer cartels
108
How do costs of production influence supply
- if business has increase in costs but selling price stays same, they make less money
- they will put up prices in order to avoid making a loss
- less is thus supplied at each price => curve shifts left
- if they have decrease in costs, it shifts right
109
How does the price of other goods influence supply
- joint supply is where production of one good automatically causes production of another good
- increased production of first good increases supply of second good
- competitive supply is where production of one good prevents supply of another
- increased production of first good decreases supply of second good
110
How does weather influence supply
- supply of some goods is dependent on weather
- e.g. if weather is good, more wheat will be produced so curve shifts right
111
How does technology influence supply
- if new technology is introduced, it leads to fall in production costs as there is higher productive efficiency
- encourages firms to lower prices or produce more for same price, causing right shift
112
How do goals of the supplier influence supply
- if supplier is motivated by helping society and providing a service, they may increase supply even when that doesn’t provide extra profit
113
How does government legislation influence supply
- some legislation automatically increases supply of a good causing right shift
- however, high levels of regulation may increase costs and decrease supply
114
How do taxes and subsidies influence supply
- tax decreases supply
- subsidy increases supply
115
How do producer cartels influence supply
- some firms or countries come together in order to decrease supply and therefore increase price of their good to increase profit
116
What is price elasticity of supply
- PES
- responsiveness of supply give a change in price of goods
117
How do you work out PES
Change in quantity supplied / change in price
118
What are values for PES
- unitary elastic => PES=1
- relatively elastic => PES>1
- relatively inelastic => PES<1
- perfectly elastic => PES=infinity
- perfectly inelastic => PES=0
119
What are factors affecting PES
- time
- stocks/finished goods
- spare capacity
- perishability
120
How does time affect PES
- impact on amount of good that can be supplied at any price
- in short term, firm could sell more products but still be restricted by FoPs meaning it still is relatively inelastic
- in long term, they can increase factors therefore supply is elastic
- long the period of time the supplier has to make a change and increase production, more elastic it is
121
How do stocks/finished goods influence PES
- if business has stockpile, then when prices go up, they can use excess supply from stockpile meaning it is elastic
122
How does spare capacity influence supply
- if business not utilising all FoPs, and there is an increase in price, they can increase FoPs and minimise spare capacity, making it elastic
123
How does perishability influence PES
- more perishable the good is, the less elastic it is
124
What is price determination
- equilibrium point refers to point where there are no more forces thar bring about changing prices
- price equilibrium is where supply = demand (market clearing point)
125
What is excess demand
- if price set below equilibrium, then there is excess demand
- as a result, there is a shortage in market
- firms can charge higher prices, causing extension in supply and a contraction in demand
126
What is excess supply
- if price set higher than equilibrium, there will be excess supply
- firms will have unsold goods and encourage them to sell excess goods on sale, causing prices to fall and supply to contract and demand to extend
127
What is the price mechanism
- in free market, prices determined by price mechanism
- determines how much is bought and sold
- Adam Smith => invisible hand
128
What are the functions of the price mechanism
- rationing
- signalling
- incentive
129
What is the rationing function of the price mechanism
- price system is a way of rationing goods
- when price increases, some people cannot afford to buy good and some may not have desire
- limited resources can be rationed and allocated to people who can afford them and value them
130
What is the signalling function of the price mechanism
- price mechanism acts as a signal where resources should be used
- when prices rise, producers move resources into manufacture of that product
- change in price indicates to suppliers and consumers that market conditions have changes so they should change quantity bought and sold
131
What is the incentive function of the price mechanism
- acts as inventive for people to work hard
- buyers realise with more money they can buy more goods
- suppliers realise with more produced, they can make more money
- low prices act as incentive for consumers to buy more of a good and high prices incentivise more selling for suppliers
132
Explain the price mechanism in the context of a local market
- coronavirus pandemic disrupted supply chains across planet
- many countries blocked imports to prevent spread
- if we take example of British supermarkets, less imports from other countries means there are fewer goods on supermarket shelves
- as demand for food is high but supply is low, price of food raises to ration excess demand so only consumers who value food buy them
133
Explain the price mechanism in the context of a national market
- price of housing differs across the UK => high in south and low in north
- London is not only the capital but also second largest financial centre in the world
- population of London is relatively high compared to rest of UK so house prices rise through rationing
- house prices also incentivise firms to allocate resources to production of more houses, as there is profit to be made
134
Explain the price mechanism in the context of a global market
- in 1973, OPEC proclaimed an oil embargo due to geopolitical factors regarding America and the Middle East
- sent price of oil at record breaking levels across the planet, as oil was an invaluable resource to countries
- shows rationing function as disequilibrium of supply and demand meant high prices deterred consumers who didn’t value oil highly, which left market open only to those consumers who did
135
What is consumer surplus
- difference between price consumer is willing to pay and price they actually pay, set by price mechanism
136
What is producer surplus
- difference between the price the supplier is willing to produce their product at and the price they actually produce at, set by the price mechanism
137
What do consumer and producer surpluses show
- economic gain from buying and selling of the good
- consumer surplus shows welfare gained by consumers
- total satisfaction consumers receive is total area under demand curve
- producer surplus shows economic gain from selling
138
How does elasticity affect producer and consumer surplus
- perfectly elastic demand means there is no consumer surplus
- perfectly inelastic demand means that consumer surplus is infinite
- the more inelastic demand is, the higher consumer surplus likely to be
- when supply is perfectly elastic, producer surplus is 0
- when supply is perfectly inelastic, producer surplus is infinite
139
How do changes in supply and demand affect producer and consumer surplus
- decrease in demand/supply leads to decrease in both producer and consumer surplus
- increase in demand/supply leads to increase in both producer and consumer surplus
140
What is an indirect tax
- tax on expenditure
- person who is ultimately charged tax is not the person responsible for paying sum to government
- business is required to pay tax but customer is charged instead
141
What are the types of indirect taxes
- ad valorem tax
- specific tax
142
What is an ad valorem tax
- tax increases in proportion to value of good
- tax is a percentage of cost for the good
143
What is a specific tax
- amount is added to price
- constant, parallel
144
Explain the impact of a tax
- causes inward supply shift as it increases cost of production
- leads to rise in prices and fall in output (diagram)
- consumers suffer higher tax burden from high prices
- producers suffer higher tax burden from high costs
- government gains tax revenue => producer + consumer burden
145
What is the incidence of tax
- tax burden on the taxpayer
- if PED is perfectly elastic / PES is perfectly inelastic, supplier pays all the tax
- if PED is perfectly inelastic / PES is perfectly elastic, tax passed onto consumer
- more elastic the demand is / less elastic the supply is, the lower the incidence of tax on the consumer, meaning suppler pays more
- ceteris paribus, more inelastic demand => higher tax revenue for government as demand does not see fall
146
What is a subsidy
- grant given by government
- payment to encourage production/consumption of a good or service
147
Explain the subsidy diagram
- subsidy increases supply as cost of production falls
- therefore rise in output and fall in prices
- total area shows government spending
148
Explain the synoptic point for taxes and subsidies
- both can have macroeconomic effects
- e.g. subsidies can be used to encourage exports or protect domestic industries
- indirect taxes can be regressive
- both have implications on government budget
149
Explain the synoptic point for producer and consumer surplus
- macroeconomic policies can be assessed by considering their effect on producer and consumer surplus
- e.g. use of tariffs leads to loss of consumer surplus
150
What are reasons preventing consumers from acting rationally
- influence of others
- habitual behaviour / consumer inertia
- weakness at computation
- lack of knowledge
151
What is market failure
- occurs when market fails to allocate scarce resources efficiently
- causes loss in social welfare
152
What are the types of market failure
- externalities
- under provision of public goods
- information gaps
153
What are externalities
- cost/benefit received by a third party from an economic transaction outside of the market mechanism
- leads to over/under production of goods => resources aren’t allocated efficiently
154
What is under provision of public goods
- public goods are non rivalry and non excludable
- means they are under provided by the private sector due to free rider problem
- market is unable to ensure enough of these goods are provided
155
What are information gaps
- information gaps exist when either the buyer or seller does not have access to the information needed for them to make a fully-informed decision
156
What are the different types of externalities
- private costs/benefits => costs/benefits to individual participating in economic activity
- social costs/benefits => costs/benefits of the activity to society as a whole
- external costs/benefits => costs/benefits to third party not involved in economic activity, difference between private and social costs/benefits
157
What is a merit good
- good with external benefits
- benefit to society is greater than the benefit to the individual
- goods tend to be underprovided by free market
158
What is a demerit good
- good with external costs
- cost to society is greater than cost to individual
- over provided by free market
159
What do externality diagrams look at
- marginal costs and benefits
- extra cost/benefit of producing/consuming one extra unit of the good
- e.g. MPB is extra satisfaction gained from individual consuming one more of a good and the MSB is extra gain to society from consumption of one more good
160
Draw and explain a negative production externality diagram
- negative externalities of production occur when social costs are higher than private costs
- market left to operate freely will ignore external costs
- produces where MPB=MPC at market equilibrium
- at Q1, society costs are higher than benefits, resulting in welfare loss => AB
- economy should produce at social optimum position of MSB=MSC
- difference between MSC and MPC increase as output grows, as external costs grow the more people do it
161
Draw and explain a positive consumption externality diagram
- positive externalities of consumption occur when SBs are higher than SCs
- market left to its own devices and will produces at MPB=MPC, and will not consider benefits to society
- if market considers all benefits, it would produce at MSB=MSC
- failure of market to consider external benefits led to misallocation of resources so there is underproduction
- leads to welfare loss => AB
- difference between MPB and MSB grows since external benefits grow from consumption
162
How can size of externalities be calculated
- difficult to work out size of externality
- tends to be placed on value judgements => difficult to monetise external costs
- many externalities involved with information gaps => people are unaware of the full implications of their decisions
163
How can government intervention reduce externalities
- indirect taxes and subsides => taxes can be put on goods with negative and subsides on positive
- tradable pollution permits => allow firms to produce certain amount of pollution
- provision of the good => high SBs so government may provide through taxation
- provision of information => helps people make informed decisions
- regulation => limit consumption, e.g. ban advertising
164
What are public goods
- missing from free market but offers benefits to society
- non rivalry => one person’s use of the good does not stop someone else from using it
- non excludable => cannot stop someone from accessing good and someone cannot chose not to access the good
165
What are quasi public goods
- quasi public goods / non pure public goods
- goods which aren’t perfectly non rivalry and non excludable but aren’t perfectly rival or excludable
- e.g. roads which are semi excludable as there could be tolls and semi rivalry as people don’t use up roads but congestion causes problems during rush hour
166
What is the free rider problem
- says you cannot charge an individual a price for the provision of a non excludable good as someone else will gain benefit from it without paying anything
- free rider is someone who receives benefits without paying for it
- private sector producers do not provide public goods as they cannot be sure of making profits, due to non excludability of public goods
- therefore if provision of public goods was left to market mechanism, market would fail
167
What are the different type of information
- symmetric information => buyers and sellers have potential access to same information => perfect information
- however many decisions are based on imperfect information so economic agents are unable to make informed decisions
- asymmetric information => one party has superior knowledge compared to another
- usually seller has more information than buyer => can take advantage and charger more
168
How do information gaps lead to market failure
- misallocation of resources
- people do not buy things that maximise their welfare
- means that consumer demand or producer supply for a good may be too high or low
- price and quantity are thus not in social optimum position
- economic agents are unable to make rational decisions
169
What can influence information gaps
- advertising leads to information gaps
- designed to change attitudes of consumers to encourage them to buy good
- may cause them to think benefits are greater than they actually are
- increases in technology reduces information gaps as people can get more information
170
What are examples of information gaps
- drugs => users do not see long term problems
- pensions => young people do not see long term benefits
- financial services => suppliers have more information than consumers so abuse customers for their own benefit
