the market mechanism market failure and government intervention in markets

what is the main why of allocating resources in a market?

price

What is the price mechanism?

changes in demand and supply lead to changes in price and quantity bought and sold

Functions of the price mechanism

Rationing, signalling, incentive

how does price mechanism act as a rationing source?

high demand means supply is limited so price is high, supply is restricted to those who can afford it

how does price mechanism act as a signalling source?

changes in price show changes in demand and supply

advantages of price mechanism

resources are allocated efficiently, doesn't need anyone to regulate it (no employees), consumers decide what is and what isn't produced, prices are kept to a minimum as resources are used as efficiently as possible

disadvantages of price mechanism

inequality in wealth and income, under provision of goods and over provision of demerit goods, people with limited skills or ability to work will suffer unemployment or receive low wages, public goods wont be produced

when does partial market failure occur?

when a market exists but that market fails to allocate resources efficiently

when does complete market failure occur?

when the market does not exist at all

when does a negative production externality occur?

when a marginal social cost of production is greater than the marginal private cost of production

who does a negative production externality impact

it has a negative impact in a third party

what is a private cost?

the cost paid solely by the producer which includes all costs of production

what is an external cost?

the cost to a third party

who is the third party?

neither a producer or a consumer of the production who still suffers a negative impact

what is a social cost?

private cost + external cost

marginal social cost =

marginal private cost + external cost

what is an external cost resulting from production known as?

negative production externality

where does market equilibrium occur on an externality diagram?

MPB=MPC

where is social optimum on an externality diagram?

MSB=MSC

what are the impacts of a negative consumption externality?

over consumption of Q1, price is too high, welfare loss

when does a negative consumption externality occur?

when a marginal social benefit is less than the marginal private benefit

when does a positive consumption externality occur?

when MSB is greater than a marginal private benefit

examples of positive external benefits

health benefits to society from accessing the NHS, increased productiveness of the UK economy through accessing education, not using up vital NHS resources through healthy eating

outcomes of positive consumption externality

product is under consumed and there is a welfare gain

when does a positive production externality occur?

when the marginal social cost is less than the marginal private costs which gives an external benefit to a third party member

examples of a positive production externality

fish farm cleaning up a river will benefit a distillery downstream, a bee farm has its bees pollinating a local orchard helping that business

what is a merit good?

goods that produce an external benefit to both consumers of the good as an external party, the marginal social benefit is greater than the marginal private benefit

outcomes of a merit good?

underconsumption and welfare gain

examples of merit goods

education, healthcare and healthy eating

What is a demerit good?

a good where the social cost of consumption is higher than the private cost

examples of demerit goods

cigarettes, alcohol, gambling

how do public goods cause market failure?

because of the problem of missing markets

main characteristics of public goods

non-excludability, non-rival consumption, non-resectable, may fail to supply the optimum quantity, pure public goods aren't usually provided by the market, government decide output level

examples of public goods

flood defences, sanitation infrastructure, national defence

why is healthcare not a public good?

it is a rival and excludable in consumption

what is the free rider problem?

when some consumers benefit from another consumer purchasing a good

what is a private good?

a good that is both rival and excludable

What is a quasi-public good?

goods that display elements of both public goods and private goods

example of a quasi-public good

digital broadcasting

what is symmetric information?

where both parties in a transaction have the same information

What is asymetric information?

when sellers have more information than consumers

Monopoly as market failure

high price, low output (less choice), deadweight welfare loss, no static efficiency

types of immobile factors of production

geographical, occupational

Reasons for geographical immobility

high cost of moving, reluctant to leave family and friends, a dislike of change, imperfect information about jobs available in different areas

Reasons for occupational immobility

lack of training, education and skills needed for a different jobs, lack of required qualifications, lack of work experience

immobile factors of production =

inefficient use of resources

how can the government help correct immobile factors of production?

offer relocation subsidies or mortgage relief, offer incentives for construction in certain areas, provide more training programs

what is state provision?

Goods and services provided directly by the government from tax revenue

disadvantages of state provision

less incentive to operate efficiently as it lacks the price mechanism, may fail to respond to consumer demand as it lacks profit motives, it can reduce individuals self-reliance

what is privatisation

The transfer of ownership of a firm from the public sector to the private sector

advantages of privatisation

increases competition and efficiency, improves resource allocation, PFI means lower taxes in the short run, government gain revenue for selling firms

disadvantage of privatisation

extra measures to avoid a monopoly forming, less focus on safety and quality, a PFI will often cost more in the long run and will add to government debt, PFIs mean higher taxes for future generations

What is PFI?

Private Finance Initiative, private firms are contracted to complete and manage public projects

what areas does regulation help?

reduce the number of demerit goods and services, reduce the power of monopoly, provides some protection for consumers and producers from problems arising from asymmetric information

what does deregulation do?

removes some barriers to entry so it can increase competition (specifically in monopoly markets) which tackles market failure

advantages of deregulation

improves resource allocation, if used alongside privatisation it can be used to prevent privatised firms becoming privatised monopolys, improves efficiency

disadvantages of deregulation

difficult to deregulate some natural monopolies, it can't fix some methods of market failure such as negative externalities or immobile factors of production, may mean there's less safety and production for consumers

what is competition policy?

governments can choose to intervene in concentrated markets where monopoly power is causing market failure

what do the CMA and the European Commission monitor when looking out for unfair competition?

mergers and agreements between firms,

examples of regulation in markets by government?

payment protection insurance (PPI) and mobile phone roaming charges

how do governments intervene to help consumers?

try provide information on costs and benefits to help consumers to make rational choices and prevent market failure caused by asymmetric information

examples of how governments intervene to help consumers

school and hospital league tables, campaigns for healthy eating and compulsory food labels

what is nationalisation?

State ownership of key industries

how does nationalism give control to governments?

they can provide better provision that industries provide better goods and services, they can se output and prices of goods to benefit society, easier to regulate, can pay workers a good wage, can pay suppliers a good price

issue with nationalisation

inefficient since they're not driving to reduce costs and make profits

why do governments promote small businesses?

to increase competition so that consumers get a lower price and more choice

ways governments can intervene

privatisation and regulation

what are ad valorem taxes?

indirect taxes where a certain percentage is added on to the price of each unit sold

What is VAT an example of?

ad valorem tax

what is an indirect tax?

A tax on expenditure

advantages of using taxation to reduce negative externalities

it does reduce consumption and production to reduce the externality, any tax revenue gained can be used to help clean up the effects of the externality

disadvantages of tax

difficult to get a monetary value of the tax correct, a good with inelastic demand won't be effected by taxation, increasing a firms costs will make them less competitive, pollution taxes can encourage firms to move abroad so less tax revenue

what is a subsidy?

a grant given to firms by the government which is usually a fixed sum per item produced or sold

advantages of a subsidy

GAIN IN CONSUMER WELFARE IN THE FORM OF HIGHER CONSUMER SURPLUS, consumers also reduce consumption of negative consumption or production of externalities

disadvantages of a subsidy?

subsidising the wrong product may lead to over production, difficult to set the correct level of subsidy, difficult to choose what product to subsidise, opportunity cost (not everything can be subsidised)

what is a minimum price?

a price floor set by the government

where does the minimum price need to be set to be effective?

above the equilibrium

what are the impacts of minimum price?

demand for the product will fall, supply of the product will increase (due to the new profit motive)

where is the maximum price set?

below equilibrium

effects of maximum price

either an excess in demand or a shortage in supply

how can maximum prices shortage be resolved?

first come first served or rationing the product

why does the buffer stock system tend to fail?

too many bad harvests at the beginning of the harvest, the cost of purchasing the surplus can be excessive, costs of storage, wastage when stores deteriorate, products tend to be over produced

how do pollution taxes work?

it increases the MC of the product which causes a fall in demand

examples of pollution taxes

carbon tax in British Columbia, emissions trading schemes, chinas smoking tax, landfill tax

advantages of pollution taxes

makes the polluter pay, utilises the price mechanism to change incentives and choices, raises tax revenue which might then be used to address other market failure

disadvantages of pollution taxes

inelastic demand will mean there's little change, risk often evasion and avoidance, may hit low income families

examples a carbon emission trading scheme

EU carbon emissions trading scheme

advantages of carbon emission trading

reduces pollution, encourages firms to be more efficient, can sell their permits, revenue gained can be reinvested into pollution reduction schemes

disadvantages of carbon emission trading

optimal pollution level is difficult to set, create new markets so could cause market failure within the market, high levels of pollution in specific areas is very harmful, admin costs

issues with extension of property rights

it can be difficult to do, externalities can affect more than one country, high costs in suing an individual or company, difficult to put value on its use, difficult to trace the source of environmental damage

When does government failure occur?

when government intervention results in either the situation becoming worse or the creation of a totally new product

what is political self interest?

when governments make decisions that are influenced by political lobbyist who influence them to not do the moral choice

what is poor value for money?

many government decisions result in huge expenses with very little positive outcomes

what is policy-short termism

going for the quick fix solution

What is regulatory capture?

when a UK regulator operates in favour of the industry rather than in the best interest of the customer

what are conflicting objectives?

when government policy results in an improvement in one objective a the expense of another

what is bureaucracy and red tape?

the cost of enforcement may hurt businesses

What is the law of unintended consequences?

attempting to solve one problem creates a whole new one

example of government failure

common agricultural policy which was set up to help farmers and its main aim is to correct market failure caused by fluctuating prices for agriculture

issues with CAP

encourages increased output which damages the environment, minimum price led to over supply, large amount of wasted food, increased food prices, increase cost to tax payers, can cause conflicts with other countries as it makes exports from non-EU countries less competitive