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Market Failure
When the price mechanism leads to an inefficient allocation of resources, leading to a net welfare loss. This means resources are not allocated to their best or optimum use.
Allocative Inefficiency
Type of ineffiency where markets fail to produce the ideal outcomes for society, scarce resources are misallocated. A good may be under produced and under consumed due to the market price being too high and vice versa.
Externalities
Otherwise known as spill-over effects, cost or benefits that are external to an exchange. They are third-party effects, ignored by the price mechanism.
Public Good
A shared good or service for which it would be inefficient or impractical to make consumers pay individually and to exclude those who did not pay.
Information Gaps
Where consumers, producers or the government have insufficient knowledge to make rational economic decisions, leading to the markets to misallocate resources efficiently and effectively.
Private Cost
A cost paid by the consumer or the producer
Social Cost
the total cost of producing a good or service, including both the private cost and any external cost such as the cost to wider society and the environment.
Negative Externality
the harm, cost, or inconvenience suffered by a third party because of actions by others, often associated with overproduction and overconsumption.
Positive Externality
a benefit received by someone who had nothing to do with the activity that generated the benefit, also involves underconsumption and underproduction.
External Cost
An uncompensated cost that an individual or firm that is on third parties that are not involved with the production/consumption decision. Such as the cost to the NHS of treating smoking effects and the cost to the taxpayer.
Positive Consumption Externality
Where your consumption decision has a beneficial impact on a third party in the future. An example of this could be getting an education, a more educated society will pay more tax and have lower crime rates.
Negative Production Externality
when a third party is adversely affected as a result of a firm's production decisions. An external cost is imposed on a third party.
Causes of market failure
Externalities, public goods, information failures, monopoly power and social immobilities and inequalities.
Divergence
Economic term for splitting or difference.
Marginal Private Cost
the cost of producing an additional unit of a good or service that is borne by the producer of that good or service.
Marginal External Cost
Cost to third parties from the production of an additional unit of output.
Marginal social cost
The total cost to society of producing an additional unit of a good or service.
Marginal Benefits
Additional benefits; the benefits connected with consuming an additional unit of a good or undertaking one more unit of an activity on both the consumer and society.
Positive Consumption Externalities involve
Marginal Social Benefits > Marginal Private Benefits
Negative Production Externalities involve
Marginal Social Cost > Marginal Private Cost
Indirect Tax
Expenditure tax that increase cost of productions for firms, which are transferred onto the consumers through higher prices.
Specific Tax
AN indirect tax calculated as an absolute amount per unit of the good or service sold. Shown by a parallel shift of the supply curve to the left.
ad valorem tax
An indirect tax where a percentage is added to the selling price of each unit, such as VAT. Shown by a pivot shift of the supply curve to the left.
Incidence of Tax
How the burden of a tax is distributed between firms and consumers.
Minimum price (price floor)
A legal price set by the government which is above the market equilibrium price on goods with a negative externality where governments feel that the going market price is too low.
Subsidy
Money grant given to firms by government to reduce the costs of production and encourage an increase in output.
Deadweight welfare loss
The loss in welfare between the MPC and the MSC arising from an inefficient allocation of resources.
Free Rider Problem
Cause of market failure associated with public goods, where individuals are not incentivized to contribute to a provision of a public good as they know others will and they will 'free ride' off their contribution without paying.
Imperfect Market Information
Cause of market failure where buyers or sellers or both lack information to make an informed or rational decision
Merit Goods
Goods or services considered to be beneficial for people that would be under-provided by the market and so under-consumed
De-merit goods
Products that are considered to be harmful for people that would be over-provided or over-consumed in a purely free market economy. These goods are generally considered to be products whose consumption creates negative externalities.
Asymmetric Information
a situation in which one side of the market has more reliable information than the other side in a transaction, such as in the second hand car market where the selling party or firm knows the car a lot better than the potential buying party.
Regressive
An indirect tax or price control which disproportionately burdens the poorer parts of society than the rich.
Maximum price (Price ceiling)
It's a price set by the government above which market price is not allowed to rise. It may be used to protect consumers from high prices, but can come with unintended consequences.
Unintended Consequence
Form of government failure where an unplanned result (usually negative and unwanted) of an incentive or government intervention in the market, contributes to a 'whack a mole' effect where the government solves one problem associated with failure but creates another. Examples include: Black market, unemployment, regressive and firms shutting down.
quasi-public goods
Evaluation for pure public goods: goods for which exclusion could occur and the private sector could provide such as toll roads and beaches, but which government provides because of perceived widespread and diffuse benefits to prevent underconsumption and underproduction.
Intervention Buying
When a government buys the excess supply of a good created by a minimum price floor
Non-rivalry
A characteristic of public goods; one person's use of the good does not prevent someone else from using it. Seen through another person moving to the UK getting protected by the Trident Deterrent.
Non-excludability
A property of a public good which means that if it is provided for one person it is provided for all.
Non-rejectability
A property of a public good which means that if the good is provided, it is impossible for the person to 'opt out' and not gain its benefits
Pure public good
a public good that is nonrival, nonexcludable and nonrejectable.
Economies of Scale
the property whereby long-run average total cost falls as the quantity of output increases
Information Failure
A lack of information from inaccurate, incomplete, uncertain and misunderstood data, resulting in consumers and producers making decisions that do not maximise welfare, even with adequate provision of information.
Principal Agent Problem
A problem caused by an agent pursuing his own interests rather than the interests of the principal who hired him, causing asymmetric information between the two parties, which is problematic due to the trust of the principal.
Moral Hazard
Arises when people behave recklessly because they know they will be saved if things go wrong
Laffer Curve
A relationship between the tax rates and tax revenues that illustrates that high tax rates could lead to lower tax revenues if economic activity is severely discouraged, a 'brain drain' or tax evasion is encouraged. There is an optimal point, where revenue is maximised.
Limitations to government intervention
Value judgements, changing prices to change incentives (PED), social science, combination of policies, power of markets (profitable solutions), law of unintended consequences.
Government Failure
When government intervention leads to an inefficient allocation of resources and a net welfare loss, meaning that the costs of intervention outweigh the benefits.
Regulatory Capture
Source of government failure: The situation that occurs when a governmental regulatory agency ends up being controlled by the industry that it is supposed to be regulating.
