Chapter 6 - Market Failure (definitions)

Efficient allocation of resources

Efficient allocation of resources implies that adequate available resources are used in the production of goods or services to bring about maximum total economic surplus. In doing so, social welfare is maximised

(Template definition) Marginal y Benefit/Cost

(y = Private, Social, External)

Measures the change in total y benefit/cost as a result of undertaking an additional unit of an economic activity

Market Failure

occurs when the workings of the free-market result in an inefficient allocation of resources from the perspective of society

Public Goods

Have the characteristics of non-rivalry in consumption, non-excludability in consumption and non-rejectability in consumption

Non-rivalry in consumption

More than one person can consume the same unit of good at the same time

Non-excludability in consumption

If the supplier cannot prevent consumption of the good once it is made available

Non-rejectability in consumption

Inability of consumers to refuse the consumption of a good

Externality

A cost or benefit arising from an economic activity that falls on a third party and is not taken into account by those who directly participate in the economic activity

Negative Externality

Gives rise to external cost which arises when individual actions inflict cost upon a third party without the latter being compensated

Positive Externality

Gives rise to external benefit which arises when individual actions generate benefits to a third party without the latter having to pay for them

Imperfect Information

Occurs when buyers and/or sellers have incomplete, inaccurate or misunderstood information of the actual benefits and/or actual costs relevant to the transaction

Asymmetric information

Situation where one party (either buyer or seller) in an economic transaction has more information than the other party

Adverse Selection

Arises when certain parties with more information naturally select themselves out of a market, which gives rise to missing markets where these parties do not get to buy or sell the good even though it may be beneficial for them to do so

Moral Hazard

A situation where a person behaves in a way that is detrimental to society because the person does not fully bear the costs of his actions

Merit Good

Goods or services that are deemed socially desirable by the government, and which are under-consumed when left to the price mechanism

Demerit Good

Goods or services that are deemed socially undesirable by the government, and which are over-consumed when left to the price mechanism

Factor Immobility

Occurs when it is difficult for factors of production to move between different industries

Occupational Immobility

Occurs when there are barriers to the mobility of workers between different industries and occupations

Due to mismatch between skills possessed by labour and those required by producers seeking labour

Geographical Immobility

When there are barriers to people moving from one geographical locality to another to find work.

Often due to inability or lack of willingness of labour to move

Equity

An outcome where society considers the distribution of resources to be fair

Government failure

Situation where government intervention causes outcome to be even more inefficient or inequitable as compared to no intervention

Market Power

A firm’s ability to set their prices above a level that would exist in a perfectly competitive market structure. Firms with market power are able to set a high price for their goods while maintaining market share