3.1.5.6 MARKET IMPERFECTIONS

Define market failure

A situation where the free market operating on its own fails to allocate resources efficiently

This results in social undesirable outcome, meaning goods and service services are either produced (pollution), Or underproduced (healthcare)

Why is information important for consumers in a market?

When consumers lack proper information, it creates a specific type of market failure, known as information failure

What can sellers do when there is lack of information?

Sellers can exploit the gap to overcharge for low quality or even dangerous goods

Give an example of a market that may have information failure

Market for cars (lemons)

Rational behavior assumes there is what type of information?

Full information

Information gaps might be holding back demand for electric cars. Can you identify two of them?

1. Battery lifespan and degradation (the lack of awareness regarding actual battery longevity hold back demand)

2. Public charging availability and reliability (buyers often do not realize that the vast majority of daily charging has done at home drivers also like clarity on whether available pupil charging services are actually working)

Identify some possible information gaps in the UK market for electric cars?

Consumer affordability, perceptions, charge, reliability, regional infrastructure, total cost, and reliability

Define asymmetric information

An imbalance in power where one party in a transaction possesses more better or different knowledge than the other (creating an unfair advantage and can lead to market failures)

In which situations might the seller know more than the buyer?

Pharmacy prescription advice, used vehicles and second hand cars, private tutoring and universities, housing market

In which situations might the buyer know more than the seller?

Market for health insurance, market for secured and unsecured loans, antique experts

Annotate the following examples of asymmetric information

Used vehicles

Sellers know the true history and mechanical condition of the vehicle

Annotate the following examples of asymmetric information

Insider dealing

Corporate insiders possessed non-puppet information about a complete financial performance or upcoming mergers

Annotate the following examples of asymmetric information

Tenants and landlords

Tenants know their own own lifestyle, habits, and availability to maintain the property, but the landlord does not know this one considering an application

Annotate the following examples of asymmetric information

Health insurance

Insurance applicants know their own health status, medical history and lifestyle risk while the insurer relies on general statistics

Annotate the following examples of asymmetric information

Borrowers and lenders

Borrowers know more about their financial health and likelihood to repay a loan, the lender is less aware of this

Annotate the following examples of asymmetric information

Product warranties

Manufacturers and retailers know the exact quality and reliability of their products, while consumers usually defects after purchase

What is the market for lemons?

A lemon is a poor quality product, such as used cars that constantly breakdown (the seller of a product knows more about it true quality than the buyer

Explain the market for lemons

Bias cannot easily tell a good product from a defective one which means they become unwilling to pay a premium price

Give examples of the market for lemons

• healthcare and insurance

• financial market

• online reviews

Why has the sales of used cars increased?

Pandemic production short falls, extended leases, new car affordability, cost of living pressures

George Akerlof and economies of information process?

• sellers know more about the quality of used vehicles than buyers

• buyers cannot tell accurately the quality of the car available for sale

• buyers will therefore offer an average price for all cars

• this is typically lower than the sellers perceived value

• some sellers were removed their good vehicles from open sale

• the average quality of cars therefore falls

• by is no longer willing to buy the average price this increases risk of market disappearing

When does market failure occur?

Where the market equilibrium results in inefficient and inequitable allocation of resources

What does information failure prevent individual from making?

Prevent individuals from making rational decisions that maximize their welfare

Which goods do consumers tend to under consume and over consume?

Under - merit goods

Over - demerit goods

What is the diagram for merit goods and market failure?

Give 6 examples of interventions to improve information

1. Health warnings

2. Nutritional labelling

3. Gamble aware

4. Industry standards

5. Consumer protection laws

6. Compulsion/changing the default

Expand on "health warnings"

Direct advisories on product packaging/advertising explicitly detailing physical or psychological risks

Expand on "nutritional labelling"

Front/back displays provide ingredient breakdowns calorie counts, and simplified nutritional grading

Expand on "gamble aware"

Public health campaigns messaging and support frameworks aimed at preventing gambling related harm and promoting self play

Expand on "industry standards"

Voluntary codes of conduct, advertising restrictions or produce standards established by businesses rather than state law

Expand on "consumer protection laws"

Legally binding rules protecting buyers from deceptive marketing, unsafe products and unfair contract terms

Expand on "compulsion/changing the default"

Making the safest or healthiest option the automatic option

• this method nudges/guides behavior without forcing anyone

How does "bounded rationality" affect decision making?

When making decisions, individuals rationality is limited by the information they have, the limitations of their minds, and the finite amount of time available in which to make decisions

How does "heuristics" affect decision making?

Mental shortcuts the brain used to speed up decision making and reduce cognitive load. They actively affect judgements

• efficiency

• bias creation

• adapt

Explain the link between monopoly power and market failure

Monopoly power causes market failure by distorting the free markets ability to allocate resources efficiently

What are some key forms of monopoly market failure?

• allocative inefficiency (P>MC)

• deadweight loss

• productive inefficiency

• higher prices restrict choice

What is the market share of the top 10 supermarkets in the UK?

Tesco - 28%

Sainsburys - 16%

Asda - 12%

Aldi - 11%

Morrisons - 8%

Lidl - 8%

Coop - 5%

Wait rose - 5%

Iceland - 2%

Ocado - 2%

Why does Tesco have such high market share?

Intense price competiton, data driven loyalty, strategic supply chains

What is the 3 largest companies in the world by market value?

1. Apple - £2.7 billion

2. Microsoft - £2.3 billion

3. Saudi Arabian oil company - £2.0 billion

Define monopoly power

A firms ability to profitability raise prices above the competitive market level without loosing all its customers (price makers)

Which 3 UK sports clothing have the highest market power?

Nike, Adidas, Puma

Draw a diagram of an improvement in consumer welfare

What are some disadvantages of monopoly power?

• prices are higher

• allocative efficiency

• regressive effects

• X-inefficiencies

• if a monopoly gets too big - leads to diseconomies of scale

What are some potential advantages of monopoly power?

• economies of scale - leads to lower average costs

• R&D

• tax revenues from high profit can flow to the government

• cross subsidies - use profits for social benefit

• a fully scaled monopoly can improve a country’s export competitiveness

What is key about a contestable market?

The key feature of a contestable market is the threat of entry from new competitors rather than the actual number of firms currently in the industry

• no barrier to entry/exit

• no sunk costs

• access to technology

Price and output in a contestable market diagram

Define factor immobility

Factor immobility occurs when factors of production cannot easily move between different areas of the economy

Explain the link between factor immobility, and market failure

Factor in mobility leads to market failure because the price mechanism fails to efficiently allocate resources (structural unemployment, productive inefficiency, market disequilibrium)

Define trade theory

A field of economic examines, how and why countries trade goods and services

Define comparative advantage

The ability of an economy to produce a specific good or service at a lower opportunity cost than its trading partners

What does over specialization risk causing?

Structural unemployment

Define structural unemployment

Long-term unemployment caused by a mismatch of skills between the workers skills and the skills required for the available jobs

What are the 4 causes of occupational immobility?

• skills gap

• experience gaps

• education gaps

• low confidence

Expand on "skills gaps"?

Workers made lack this specific technical abilities required for new roles in growing industries

Expand on "experience gaps"?

Even with the right qualifications, a lack of practical on the job history in a specific theory can prevent a worker from being hired for a different career

Expand on "education gaps"?

A lack of basic or advanced formal qualifications, can create a barrier to entry for many professional sectors

Expand on "low confidence"?

Psychological barriers, such as fear of change or belief that one cannot learn new skills, can prevent individuals from applying to jobs

What are 6 causes of geographical immobility?

• family ties

• high cost of property

• migration controls

• language barriers

• access to good schools

• high cost of commuting