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What is market failure?

Exists when the price mechanism allocates scarce resources in an inefficient way ie. either an over or under allocation of goods and services.


What are some examples of market failure?

Underprovision of merit goods such as education and healthcare as these services would only be provided to those who were willing and are able to pay.
Under provision of public goods such as street lighting and public roads because producers cannot exclude those who do not pay from benefitting front he provision of the service.
Over provision of demerit goods such as tobacco and alcohol as there is a lack go government intervention in such markets.
Abuse of monopoly power charging customer prices above market equilibrium and hence associated inefficiencies.


When does market failure occur?

When the price machine cannot allocates resources efficiently but causes external costs or external benefits of production or consumption.


What a private benefits?

Benefits of production and consumption enjoyed by a third party.


What are private costs?

Costs of production and consumption that are the actual costs incurred by a third party.


What are social benefits?

The full benefits of consumption or production ie. the sum of private and external benefits.


What are social costs?

The full costs of consumption and production ie. the sum of private and externals costs.


What are externalities?

The external costs or benefits of an economic transaction causing the market to fail to achieve the social optimum level of output where marginal social benefits equal marginal social costs MSB=MSC.


What is the marginal private benefit?

The addition value enjoyed by third parties from the consumption or production of an extra unit of a particular good or service.


What is the marginal private cost?

The additional costs of production for firms or the extra charge paid by customers for the output or consumption for an extra unit of good or service.


What are external costs/negative externalities?

Costs incurred by a third party in an economic transaction for which no compensation is paid.


What are some examples of negative externalities?

Passive smoking
Air pollution from factories
Noise pollution from nightclubs
Child obesity from junk food
Climate change from factories


What are external benefits/positive benefits?

Benefits enjoyed by a third party from an economic transaction.


What are some examples of positive externalities?

National defence
Law and order systems
Flood defence systems
Street lighting


What is the marginal social benefit?

The added benefit to society from the production or consumption of an extra unit of output ie. the sum of the MPC and marginal external costs.


What is the marginal social cost?

The extra costs of an economic transaction to society ie. the sum of the MPB and marginal external benefits.


What exerts positive externalities?

Production and consumption of public and merit goods.


What exerts negative externalities?

Production and consumption of demerit goods.


What are demerit goods?

Products that create negative externalities to a their party. Hence their production and consumption result in social costs being firewater than private costs of production and consumption MSC > MPC.


What are examples of demerit goods?

Cigarettes, alcohol and druygs.


Why do government intervene in the market?

To discourage the production and consumption of demerit goods.


What are the two ways governments try to result market failure?

Market based policies - intervention in the price mechanism to make the market forces of demand supply operate more effectively eg. taxation and tradable permits.
Government regulations - such as environmental standards.


How is taxation used to reduce the negative externalities?

Used to internalise negative externalities ie. the buyer and the seller pay for the true costs of their actions without any burden being placed on the third party.


What happens to the supply curve when the tax is implemented?

Shifts the supply curve to the left increasing the price and decreasing the quantity demanded.


What are the advantages of imposing a tax?

It increases the price and should therefore decrease the quantity demanded.
It creates tax revenue for the government which can be used on other goods and services.


What are the disadvantages of imposing a tax?

The demand for many of these products is price inelastic so the tax may have little impact on the level of consumption.
The tax on many of these products is regressive so has a greater impact on low income earners than on high income earners.
It can encourage smuggling and unofficial market activity.


What are tradable permits?

Pollution rights issued to firms thus capping the level of pollution from economic activity. The policy creates incentive not to pollute so that excess permits can be sold to other less efficient firms.


What happens when there is an increase in the demand for pollution permits?

It will raise the price of pollution rights but without affecting the level of output and hence the level of pollution. Hence an increase in the price of tradable permits also increase the opportunity cost to firms that pollute.


How else can government try to deal with negative externalities?

By imposing laws and regulations.


What are some examples of regulations?

Laws to regulate where people can drive.
Making it illegal for people to smoke, eat or use their phone while driving.
Seatbelt laws.
Motorcyclists being made to wear a he,emtn.
Laws on the minimum age people must be before legally purchasing alcohol or cigarets.
Laws restricting where people can smoke.