Microeconomic Objectives and Market Failure (Video Notes)

Vocabulary flashcards covering key microeconomic concepts from the notes.

Market failure

A situation where the free market fails to allocate resources efficiently on its own due to factors like public goods, externalities, or information failures.

Government objectives

Goals to correct market failures and improve resource allocation, such as achieving socially optimal output and reducing income inequality.

Socially optimum output

The level of output where social marginal benefit equals social marginal cost (MSB = MSC).

Public goods

Goods that are non-rivalrous and non-excludable, often leading to free rider problems and under-provision by private markets.

Non-rivalry

One person’s use of a good does not reduce its availability to others.

Non-excludability

It is difficult or costly to exclude non-payers from consuming the good.

Free rider problem

Individuals benefit from a public good without contributing to its provision, causing under-provision in markets.

Externalities

Costs or benefits of production or consumption that affect third parties and are not reflected in market prices.

Negative externality

An adverse effect on third parties (e.g., pollution) leading to social costs greater than private costs.

Positive externality

A beneficial effect on third parties (e.g., vaccination) leading to social benefits greater than private benefits.

Social welfare loss (DWL)

The loss of total welfare when market equilibrium deviates from the socially optimal outcome.

Allocative efficiency

When price reflects the social value of goods and MSB = MSC, maximizing social welfare.

Productive efficiency

Producing goods at the lowest possible cost, i.e., on the production possibility frontier (PPF).

Information failure

When buyers or sellers do not have perfect information, leading to suboptimal decisions.

Asymmetric information

One party has more or better information than the other, causing market distortions.

Adverse selection

Hidden information leads to selection of worse quality or higher-risk participants (e.g., lemons in insurance).

Moral hazard

Insured individuals may take more risks because they are protected, shifting costs to others.

Lemons problem

A specific adverse selection problem where hidden quality information drives out high-quality goods.

Marginal private benefit (MPB)

The benefit to the consumer from consuming one more unit.

Marginal private cost (MPC)

The cost borne by the producer for producing one more unit.

Marginal social benefit (MSB)

The total benefit to society from one more unit (private plus external benefit).

Marginal social cost (MSC)

The total cost to society of producing one more unit (private plus external cost).

Marginal external cost (MEC)

The external cost imposed on society per additional unit of output.

Marginal external benefit (MEB)

The external benefit conferred on others per additional unit of output.

Indirect tax (Pigouvian tax)

A tax on a good with negative externalities to internalize external costs.

Subsidy

A payment to producers or consumers to encourage activities with positive externalities or offset higher costs.

Subsidy equal to MEB

A subsidy sized to internalize the external benefits at the socially optimal level.

Legislation/standards

Government rules to limit or regulate production/consumption (e.g., pollution caps, product standards).

Bans

Prohibitions on certain products or activities to reduce negative externalities.

Public provision

The state directly provides goods/services to ensure provision, especially for public goods.

Joint provision

Public provision combined with private sector involvement to improve quantity/quality.

State-owned enterprises (SOEs)

Government-owned firms; often aim for social welfare rather than profit.

Lorenz curve

A graph showing the distribution of income or wealth within an economy.

Gini coefficient

A numerical measure of inequality from 0 (perfect equality) to 1 (max inequality) derived from the Lorenz curve.

Income inequality

Unequal distribution of income across individuals or households.

Tradable permits (cap-and-trade)

A market-based approach where firms hold permits to pollute within a cap and can trade them.

Hybrid measures

Policies that combine command-and-control with market-based instruments to reduce pollution.

Cognitive biases (saliency bias, loss aversion)

Systematic deviations in judgment that affect policy design and consumer choices.

Lemon law

Laws protecting consumers from defective goods by requiring disclosures or refunds.

National Jobs Bank

Government program to connect employers with jobseekers, reducing labour immobility.

Immobility of labour

Barriers preventing workers from moving to where jobs exist (occupational, geographical, etc.).

Frictional unemployment

Unemployment arising from the job search process in a healthy economy.

Structural unemployment

Unemployment due to mismatches between skills and job opportunities.

Efficiency wage theory

Firms pay above-market wages to reduce shirking and increase productivity, potentially causing unemployment.

Real wage unemployment

Unemployment caused when real wages are above the market-clearing level.

Occupational immobility

Inability of workers to switch occupations easily.

Geographical immobility

Inability of workers to move to different regions for work.

Compulsory consumption

Government policy requiring consumption of certain goods (e.g., immunisation) due to large external benefits.