Year 1 micro - Market failure Flashcards

Question

what are external costs

Answer 1

costs imposed on third parties who are not directly involved in the economic transaction eg pollution

Answer 2

individual consumer benefit upon consumption

Answer 3

private benefits + external benefits

Answer 4

- there is maximisation of society surplus: the sum of producer and consumer surplus, that occurs at equilibrium - maximisation of net social benefit, where MSB = MSC - where resources perfectly follows consumer demand, no excess

Answer 5

- there are many buyers and sellers in the market - both buyers and sellers have perfect information - there are no barriers to entry - firms are profit maximisers and consumers are utility maximisers

Answer 6

when there is a misallocation of scarce resources at the socially optimum level of output

Answer 7

Externalities: Negative Externalities: These occur when the actions of one party (e.g., a producer) impose costs on a third party not involved in the transaction (e.g., pollution from a factory harming nearby residents). The market doesn't account for these external costs, leading to over-production and under-provision of the good/service. Positive Externalities: These occur when the actions of one party create benefits for a third party not involved in the transaction (e.g., a new business providing training for its workers benefits the entire labor market). The market doesn't fully capture these benefits, leading to under-provision of the good/service. 2. Public Goods: Non-excludability: Public goods (like streetlights or national defense) are non-excludable, meaning it's impossible to prevent someone from benefiting from them even if they don't pay. This leads to the "free-rider problem," where individuals may not be willing to pay for the good, and the market under-provides it. Non-rivalry: Public goods are also non-rivalrous, meaning one person's consumption of the good doesn't diminish another person's ability to consume it. This further discourages private provision as there's no incentive to charge for the good. 3. Imperfect Information: Information failure: This occurs when consumers or producers lack complete and accurate information, leading to misallocation of resources. For example, consumers might purchase a demerit good (like cigarettes) without fully understanding its health risks, or producers might misjudge consumer demand. Asymmetric information: When one party has more or better information than the other, it can lead to market failures. For example, a used car seller may know more about the car's condition than the buyer. 4. Market Power: Monopolies: When a single firm controls a market, it can restrict output and raise prices, leading to a misallocation of resources and reduced consumer welfare. Monopolies may also abuse their power through unfair pricing practices. Abuse of Monopoly Power: Monopolies can exploit their market position by charging higher prices, reducing product quality, or restricting innovation, ultimately harming consumers. 5. Other Causes: Inequality: Large income and wealth disparities can create social and economic problems, hindering efficient resource allocation. Factor Immobility: The inability of factors of production (labor, capital, land) to move easily from one sector to another can lead to unemployment and inefficient resource allocation.

Answer 8

costs on third parties because of the actions of a separate agent

Answer 9

- costs to 3rd parties as a result of the actions of producers - air pollution (general public) - resource depletion (future gen) - resource degradation (residents affected by waste - deforestation

Answer 10

- MSC > MPC - welfare loss triangle points towards the social optimum - Firms are ignoring social costs because of self interest, leading to over production - prices are too low at p1, p1 only accounts for private costs, not external/social costs - These result in a misallocation of resources

Answer 11

Costs to 3rd parties as a result of the actions of consumers - For example, smoking, alcohol, sugary drinks, and fast food

Answer 12

- MSB < MPB - welfare loss points to the social optimum - Consumers prioritise their own private benefits over social benefits due to self interest or

Answer 13

benefits to third parties as a result of the actions of consumers/producers - eg healthcare - excercise - healthy eating - in work training - research and development

Answer 14

- in consumption - MSB > MPB - in production, MSC < MPC

Answer 15

social benefits are greater than social costs, by not producing extra units of quantity demanded, we lose out on potential extra social benefit - underconsumption and underproduction

Answer 16

Short-Term Relief vs. Long-Term Impact - While maximum prices provide immediate affordability for consumers, they may disincentivize producers in the long run. - Asymmetric info - govt may set the cap too high or too low - Maximum prices are more effective in markets with relatively elastic supply, where producers can adjust to meet demand. Evaluation: In markets with inelastic supply (e.g., housing), shortages are more likely, reducing the policy's effectiveness. Targeting Essential Goods - Maximum prices are most beneficial for essential goods and services, ensuring affordability for low-income households. - If applied to non-essential goods, the policy may have minimal social benefit while still creating distortions in the market. Maximum prices benefit those who can access the good at the capped price. However, shortages may exclude some consumers altogether. . Risk of Shortages - Maximum prices below the market equilibrium may lead to excess demand and insufficient supply.. Black Markets - Artificially low prices can incentivize illegal markets, where goods are sold at higher prices. in the case of excess demand - The scale of black markets depends on enforcement strength. Quality Decline - Producers might cut corners to maintain profitability under capped prices, resulting in lower-quality goods and services. Impact on Supply - Reduced profitability may disincentivize production, particularly for small-scale or marginal producers.w

Answer 17

💸 Disadvantages of Indirect Taxes (Microeconomic Chains) 1️⃣ Regressive impact on income distribution: Indirect taxes (e.g., VAT) are proportional to price, not income ⟶ Lower-income consumers spend a higher percentage of their income on taxed goods ⟶ Therefore, the tax burden is heavier on the poor than the rich ⟶ Results in inequitable distribution of wealth, exacerbating income inequality 2️⃣ Increases in production costs for firms: Indirect taxes raise the cost of production (e.g., excise tax on raw materials) ⟶ Firms may pass on the higher costs to consumers by raising prices ⟶ This can reduce demand, especially for price-sensitive consumers ⟶ In the long term, firms may need to adjust their strategies (e.g., cut wages, reduce output) 3️⃣ Potential for inflationary pressures: When firms increase prices due to higher tax costs ⟶ Overall price level in the economy rises ⟶ Cost-push inflation occurs, especially if the tax is imposed on key products (e.g., energy) ⟶ This leads to a general rise in prices, hurting consumers' purchasing power 4️⃣ Unintended effects on consumer behavior: If the indirect tax is imposed on a good with inelastic demand (e.g., cigarettes) ⟶ The tax may not lead to significant reductions in consumption ⟶ Consumers continue buying the product despite higher prices ⟶ This can reduce the effectiveness of the tax in achieving its desired outcome (e.g., reducing smoking) 5️⃣ Administrative costs and complexities: Monitoring and enforcement of indirect taxes can be expensive and time-consuming for governments ⟶ Collection mechanisms may require additional staff, systems, and regulations ⟶ Small firms may face disproportionate compliance costs ⟶ Inefficiency arises if the cost of collection exceeds the revenue raised

Answer 18

- The success of indirect taxes often depends on being paired with other policies, such as subsidies for healthier alternatives or investments in green technology. - Indirect taxes may inadvertently encourage undesirable outcomes, such as black markets or tax evasion - The success of an indirect tax in reducing harmful consumption depends on the good's price elasticity. Evaluation: For inelastic goods, complementary policies like public education or subsidies for alternatives may be necessary.

Answer 19

Producers Higher and Stable Incomes: Producers benefit from a guaranteed minimum price, ensuring a stable income, particularly in volatile markets like agriculture,where prices can fluctuate significantly due to factors like weather conditions and global supply changes Encourages Investment: Predictable earnings encourage long-term investment in quality and efficiency. Consumers - Reduced Overconsumption: Higher prices on demerit goods (e.g., alcohol) can discourage excessive consumption, leading to societal benefits. Government - Reduction in Negative Externalities: For harmful goods, a minimum price can help reduce associated societal costs (e.g., healthcare for alcohol-related illnesses). - Market Stabilization: Minimum prices can stabilize markets during periods of low demand or oversupply Protecting producers: A minimum price can ensure that producers receive a certain income level, particularly in sectors where production costs are high, or market fluctuations may lead to unstable incomes. Agricultural products, for example, often have minimum prices to protect farmers. Encouraging production: By guaranteeing a higher price, a minimum price can provide an incentive for producers to increase production, which may be essential for food security or other strategic sectors.

Answer 20

Guaranteed higher prices may lead to surplus production, particularly in agricultural markets. , may cause firms to not earn enough profit and eventually leave the market - Some industries may become reliant on minimum price schemes for survival. 1. Excess Supply and Government Surpluses A minimum price set above the equilibrium price leads to excess supply, as producers are willing to supply more than consumers demand. This surplus can be costly for governments, as they may need to buy and store excess goods (e.g., in agricultural markets) or risk wastage. 2. Higher Prices for Consumers Since the minimum price prevents goods from being sold below a certain level, consumers face higher costs. This can reduce affordability, particularly for essential goods such as food and housing, disproportionately affecting low-income households and leading to lower overall consumer welfare. 3. Risk of Black Markets and Illegal Sales When official prices are kept artificially high, some buyers may seek cheaper alternatives through informal or illegal markets. This undermines the policy’s effectiveness, leading to enforcement costs and potential losses for legitimate businesses. 4. Inefficiency and Resource Misallocation By artificially inflating prices, inefficient producers who would otherwise exit the market continue to operate. This distorts resource allocation, as firms have less incentive to innovate, cut costs, or improve productivity since they are guaranteed a higher price regardless of efficiency.

Answer 21

Impact on Equity - A minimum price may disproportionately affect low-income consumers, particularly if applied to essential goods. Mitigating measures like targeted subsidies or tax relief can address this. Market Efficiency - While a minimum price may stabilize producer incomes, it risks distorting market dynamics by encouraging overproduction or reducing consumer demand. Elasticity of Demand - The effectiveness of minimum pricing depends on the price elasticity of the good. For inelastic goods, consumers may continue to purchase despite higher prices, while for elastic goods, demand could fall significantly. Targeted Application - Minimum pricing works best when targeted at specific markets with clear externalities, such as alcohol or agriculture. Broad implementation may cause inefficiencies. Complementary Policies - Minimum pricing may need to be supported by other measures, such as investment in storage for surplus goods, subsidies for low-income households, or public awareness campaigns about harmful goods.

Answer 22

Labour immobility refers to the inability of workers to move between jobs due to barriers like a lack of skills (occupational immobility) or geographical constraints.

Answer 23

- benefits or costs outside the market transaction - social - private benefits or costs

Answer 24

the excess social cost over social benefit for a given output

Answer 25

🌾 1. Supports domestic producers → * Subsidies lower production costs for domestic firms → * This increases their competitiveness against foreign imports → * Market share of domestic firms can grow → * Helps protect and develop infant industries or maintain strategic sectors. 👩‍⚕️ 2. Promotes merit goods → * Subsidies on healthcare or education reduce consumer prices → * Encourages higher consumption of socially beneficial goods → * Leads to positive externalities (e.g. better health, higher productivity) → * Improves long-term social welfare and economic development. 🔋 3. Encourages green innovation → * Subsidies for renewable energy reduce upfront costs for firms → * Incentivises R&D in low-carbon technologies → * Increases supply and reduces prices of green energy → * Helps tackle climate change and meets sustainability goals. 🏗 4. Boosts employment in key sectors → * Subsidies can help labour-intensive industries stay profitable → * Prevents mass layoffs or closures in struggling regions → * Protects jobs and stabilises local economies → * Reduces regional inequality and social disruption. 📉 5. Tackles market failure from underproduction → * In markets with positive externalities, private firms may underproduce → * Subsidies help bridge the gap between private and social benefit → * Increases equilibrium output to the socially optimal level → * Corrects market failure and improves allocative efficiency.

Answer 26

2️⃣ Correcting negative externalities (market failure): Indirect taxes can be used to internalize negative externalities (e.g., pollution, smoking) ⟶ Taxing goods that cause harm (e.g., cigarettes, carbon emissions) increases the price ⟶ Reduces demand for these harmful goods ⟶ The higher prices incentivize consumers and firms to seek alternatives or reduce consumption, improving social welfare 3️⃣ Encouraging consumption of merit goods: Indirect taxes on goods with negative externalities (e.g., sugary drinks) can be used to discourage consumption ⟶ In contrast, the revenue raised could be used to subsidize merit goods (e.g., education, healthcare) ⟶ This can increase access to essential services and encourage healthier lifestyles ⟶ Helps align private consumption with societal benefits 4️⃣ Greater ease of administration: Indirect taxes are relatively easy to collect and enforce compared to direct taxes (e.g., income tax) ⟶ Taxes are paid by consumers at the point of sale, reducing the administrative burden on the government ⟶ Businesses handle the collection, reducing the need for complex enforcement mechanisms ⟶ This lowers overall administrative costs and increases efficiency 5️⃣ Less distortion of labor market incentives: Indirect taxes do not directly affect wages or employment decisions ⟶ Unlike direct taxes (e.g., income tax), they do not distort the incentives to work ⟶ Workers’ decisions are less affected by indirect taxes ⟶ This results in a more efficient labor market, as there is no disincentive to work or produce 6️⃣ Flexibility in targeting specific products: Indirect taxes can be targeted at specific goods or industries (e.g., alcohol, tobacco, fuel) ⟶ Allows the government to apply taxes on products that are socially undesirable or associated with externalities ⟶ Can be used to target particular sectors of the economy and control the behavior of producers and consumers ⟶ Ensures precision in addressing specific market failures

Answer 27

1️⃣ 💰 High opportunity cost for the government: Subsidies must be funded from government revenue, usually through taxation or borrowing ⟶ This money could be used elsewhere (e.g., healthcare, education, or debt repayment) ⟶ Creates an opportunity cost—other public goods may be underfunded ⟶ Leads to resource misallocation in the wider economy 2️⃣ 📉 Encourages inefficiency among firms: Guaranteed subsidies reduce the need for firms to improve productivity or reduce costs ⟶ Firms may become complacent, relying on state support to stay profitable ⟶ Can create productive inefficiency over time ⟶ Wastes resources that could be better used in more efficient sectors 3️⃣ 📊 May distort market signals and resource allocation: Subsidies lower prices artificially, leading to overconsumption of the subsidised good ⟶ Consumers ignore the true cost of production ⟶ May result in overproduction or overuse of certain goods (e.g., fossil fuels or water) ⟶ Leads to allocative inefficiency and potential environmental damage 4️⃣ 🎯 Hard to target subsidies effectively: It can be difficult for governments to identify which industries or groups need subsidies most ⟶ Poor targeting may mean that wealthier firms or consumers benefit unfairly ⟶ For example, energy subsidies may help large corporations more than low-income households ⟶ This reduces equity and fails to meet policy goals

Answer 28

1️⃣ 🎯 Depends on the price elasticity of demand/supply: The effectiveness of taxes or subsidies depends on how responsive consumers/producers are ⟶ If demand is inelastic, a tax may raise revenue but won’t significantly reduce consumption (e.g., cigarettes) ⟶ On the other hand, if demand is elastic, even a small subsidy could dramatically increase consumption ⟶ Therefore, elasticities determine how effective the intervention is at correcting the failure 2️⃣ 📊 Depends on the accuracy of government intervention: Government must estimate external costs or benefits to set the right level of tax/subsidy ⟶ If it overestimates, the tax may be too high and reduce consumption too much ⟶ If it underestimates, the policy may be too weak to fix the failure ⟶ Hence, the policy is only effective if the valuation of externalities is accurate 3️⃣ 💰 Depends on the cost to the government/taxpayer: Policies like subsidies or public provision can be very expensive ⟶ May lead to higher taxes or cuts in other services (opportunity cost) ⟶ If the fiscal cost is too high, the policy may not be sustainable long-term ⟶ This limits its practical application, even if it's theoretically effective 4️⃣ ⚖️ Depends on enforcement and administration: Laws and regulations may work in theory, but are only effective if enforced properly ⟶ Without monitoring, firms may ignore regulations or cheat the system ⟶ Administrative costs can also be high, reducing efficiency ⟶ The institutional capacity of the government affects the success of any policy 5️⃣ 🌍 Depends on the scale of the market failure: Some externalities (like climate change) are global, while others (like local pollution) are regional ⟶ A national tax may not work if the problem crosses borders ⟶ International coordination might be needed (e.g., global emissions) ⟶ Therefore, the scope of the failure affects how effective national policies are 6️⃣ 🗳️ Depends on political feasibility and public support: Some policies may be politically unpopular (e.g., carbon taxes, congestion charges) ⟶ Governments may avoid implementing them, or reverse them after elections ⟶ Without public buy-in, enforcement and compliance may be weak ⟶ So, political acceptability plays a key role in long-term success

Year 1 micro - Market failure Flashcards

(54 cards)