Econ U1 - market failure

Market failure

When free market fails to allocate scarce resources at socially optimum level of output

Positive externalities

Spill over benefits enjoyed by third parties arising from production/ consumption decision of someone else

Negative externalities

Spill over costs borne onto third parties arising from production/ consumption decision of someone else

Social benefits

Private + external benefit

Negative externalities of production

Overallocation of resources → opt : want less production

Positive externalities of production

Underallocation of resources → opt : want more production

Positive externalities of consumption

Undervalue of good → opt: want more consumption

Negative externalities on consumption

Overvalue of good -> opt: want less consumption

Public goods

Goods that are non-rivalry and non-excludable

Non-rivalry

Does not reduce amount available for others to consume upon consumption

Non-excludable

Hard to exclude person from benefiting

Costs( firms) of provision of public goods

Free riders

Problems arising from non-excludability (+ tiny elab)

Free rider problem → w/o pay and benefits

Problems arising from non-rivalry (+ tiny elab)

Hard to charge a price

Why is there non-provision of public goods?

Low profit incentives

Non-excludability → free riders can benefit without paying

Non-rivalry → hard to charge a price

Symmetric info

Buyers/ sellers are able to make well-informed economic decisions

Asymmetric info

Buyers/ sellers has more information than the other party

Info failure

One party lacks information to make rational decisions

Speculation

Buying / selling with expectation of a future price change with aim of gaining a profit

market bubbles

Speculation motive is one way (only buying)

Describe how market bubble progresses

1) Increase D to unsustainable levels

2) limited supply → price overinflates

3) Prices unsustainable

4) bubble bursts → panic selling

Moral hazard

One party takes excessive risks because costs of risks are partly/ fully borne onto someone else

What does moral hazard cause?

Decrease incentives to take normal precautions

Take excessive risks