Economics - Market Failure Definitions

Main forms of government intervention

1. Indirect Taxes

2. Subsidies

3. Price Controls

4. Direct Provision of services

5. Regulation and legislation

Reasons for government intervention

1. Earn tax revenue

2. Support firms & Support households on low incomes

3. Influence the level of production/consumption

4. Correct market failure

5. Reduce income inequality

Market Failure

The market results in an inefficient allocation of resources

Private Costs

Costs to those involved in the transaction

External Costs

Costs to third parties outside the transaction

Social Costs

Private Costs + External Costs

Private Benefits

Benefits to those included in the transaction

External Benefits

Benefits to third parties outside the transaction

Social Benefits

Private benefits + External benefits

Marginal Social Cost (MSC)

Additional cost to society from producing one more unit of output

Marginal Social Benefit (MSB)

Additional benefit to society from producing one more unit of output

Social Optimum/ Allocative Efficiency

The level of output where community surplus is maximised (MSC=MSB)

Deadweight Welfare Loss (DWL)

Loss in community surplus as a result of not producing at the social optimum

Public Good

Both non-excludable and non-rivalrous

Non-excludable

Once the good is provided, you cannot prevent anybody from using it

Non-rivalrous

Consumption by one person will not reduce the amount available to others

Private good

both rivalrous and excludable.

Club good

non-rivalrous but excludable

Common access resources

non-excludable but rivalrous

Free Rider Problem

Refers to someone who benefits from a good/service but avoids paying for it

Public goods will not be provided at all by the free market

No incentive to provide the good

Demerit good

A good that will be overconsumed if left to the free market because there are negative externalities in consumption

Merit good

A good that will be underconsumed if left to the free market, because there are positive externalities in consumption

Pigouvian Tax

An indirect tax that is imposed on goods with negative externalities

Carbon tax

An indirect tax on carbon dioxide emissions (a type of pigouvian tax)

Tradeable permits

are permits to pollute, issued by a governing body, which sets a maximum amount of CO2 emissions allowed. Firms may trade these permits for money.

Subsidy

Government pays a firm to produce a good/service

Tragedy of the Commons

People use the common pool resource as much as possible so others do not use it up before them