market failure & government intervention

What is market failure?

A situation where the free market fails to allocate resources efficiently, resulting in a loss of societal welfare.

What is allocative efficiency?

A situation where society's welfare is maximised because resources are allocated according to society's preferences, occurring where MSB = MSC.

What is deadweight loss (DWL)?

The loss of total economic welfare arising from an inefficient allocation of resources.

What are negative externalities?

Costs imposed on third parties not directly involved in the production or consumption of a good or service, which are not reflected in the market price.

What is Marginal Private Benefit (MPB)?

The additional benefit enjoyed by an individual from consuming one more unit of a good or service.

What is Marginal Private Cost (MPC)?

The additional cost incurred by an individual or producer from consuming or producing one more unit of a good or service.

What is Marginal External Cost (MEC)?

The additional cost imposed on third parties not directly involved in a market transaction.

What is Marginal Social Cost (MSC)?

The additional cost incurred by society from consuming or producing one more unit of a good, including external costs.

MSC = MPC + MEC

What is Marginal Social Benefit (MSB)?

The additional benefit received by society from consuming one more unit of a good, including external benefits.

What is a demerit good?

A good considered undesirable by the government because its consumption generates negative externalities and/or consumers underestimate its harmful effects due to imperfect information.

What is imperfect information?

A situation where consumers lack complete or accurate information about a good or service, potentially causing decisions that do not maximise their welfare.

What is an indirect tax?

A tax imposed on goods and services that increases producers' costs and raises the price paid by consumers.

What is a subsidy?

Financial assistance provided by the government to producers or consumers to reduce costs and encourage a particular economic activity.

What is a price ceiling?

A government-imposed maximum legal price, set below the market equilibrium price to keep a good affordable.

What is a ban?

A government policy that completely prohibits the sale or consumption of a good.

What is legislation?

Government-imposed laws and regulations that restrict or control economic activities to reduce harmful effects.

What does internalising external costs mean?

Making consumers or producers bear the external costs generated by their actions, so that private decisions better reflect social costs.