Market Failure

What is market failure?

Where the free market fails to allocate resources in the best interests of society as a whole.

What is the misallocation of resources?

Where land, labour and capital are not used as efficiently as possible.

When does market failure arise?

When externalities exist within a market

What are externalities?

Costs and/or benefits to people not included in the consumption of goods/services.

What is a negative externality?

A cost to third parties. These are known as external costs.

What is a positive externality?

A benefit to third parties. These are known as external benefits.

What are private costs and benefits?

The costs and benefits of a firm/individual that produces/consumes the good or service.

What are external costs and benefits (externalities)?

The costs/benefits to a third party, who are not involved in the consumption of the good/service.

What are social costs and benefits?

The costs and benefits that arise for the whole of society

If there are negative externalities, is the social cost greater than the private cost?

Yes

What are the negative externalities in production?

The adverse consequences to third parties arising from the manufacturing of a good or service

What are the negative externalities in consumption and give an example?

The adverse consequences to third parties arising from the purchase or use of a good or service e.g. road congestion

If there are positive externalities, is the social benefit greater than the private benefit?

Yes

What is government intervention?

Where governments intervene to correct a market failure.

What are indirect taxes?

Taxes on the consumption of goods e.g. value added tax (VAT).

What are the benefits of indirect taxes?

Higher prices reduce consumption, internalise the externality (producer pays), raise money to tackle the externality

What are the problems of indirect taxes?

Depends on PED, how much tax should be added, could cause unemployment, will it affect those on lower incomes more

What is legislation?

Laws to control the way people and organisations behave

What is regulation?

Rules, directives or government orders to control the way people and organisations behave.

What are the benefits of legislation & regulation?

The government decides how much consumption is desirable, can be legally enforced, could change attitudes in the long run

What are the costs of legislation & regulation?

Cost of enforcement (police), how much is necessary, could lead to an unofficial market

What are the benefits of prohibition?

Government can stop consumption entirely, can legally enforced

What are the costs of prohibition?

Will require effective policing, might promote illegal activity

What is information provision?

The government provides information to consumers about goods and services.

What are the benefits of information provision (negative)?

Reduces consumption, no cost to consumer or firm

What are the costs of information provision (negative)?

Could be ignored, message might not be effective, might not work for addictive goods, cost to the government

What is a subsidy?

A payment to a firm from the government to promote the supply and consumption of socially desirable goods.

What are the benefits of a subsidy?

Increases production of good with positive externality, reduces inequalities of income

What are the costs of a subsidy?

Requires taxpayer's money, opportunity cost, may not lead to increased usage, could lead to over-reliance and inefficiency

What are the benefits of information provision (positive)?

Increases consumption, long-lasting impact

What are the costs of information provision (positive)?

Could be ignored, the message might not be effective

What is state provision?

Goods and services are provided directly by the government.

What are the benefits of state provision?

Increased consumption of the good, benefits the entire country, government can decide how much to provide

What are the costs of state provision?

Can be very expensive (opportunity cost), how much should be provided, lead to inefficiencies, pressure on government to spend more

What are ways to prevent negative externalities?

Indirect taxes, legislation & regulation, prohibition, information provision

What are ways to encourage positive externalities?

Subsidies, information provision, state provision