Edexcel A-Level Economics - Market Failure

Flashcards on Edexcel A Level Economics Market Failure topics including types of market failure, positive and negative externalities, public vs merit goods, and information gaps.

What is market failure?

A situation in a free market where there is a less than optimal allocation of resources from the point of view of society, leading to allocative inefficiency through over-provision or under-provision of goods and services.

What four factors of production constitute scarce resources in an economy?

Land, labour, capital, and enterprise.

What three sources of market failure are identified in the notes?

The existence of externalities, an under-provision of public goods, and the existence of information gaps in markets.

How is an externality defined?

An external impact (cost or benefit) on a third party not involved in the economic transaction, also referred to as a spillover effect.

What is an example of a positive externality of consumption given in the transcript?

The consumption of electric vehicles, which causes $CO_2$ emissions to fall, resulting in fewer respiratory diseases for third parties.

What is an example of a positive externality of production given in the transcript?

Managed pine forests producing timber while simultaneously increasing $CO_2$ absorption, which improves climate change.

What is an example of a negative externality of consumption given in the transcript?

The consumption of alcohol, which increases anti-social behaviour and raises policing costs.

What is an example of a negative externality of production given in the transcript?

Generating electricity through non-renewable sources, which increases air pollution and leads to greater healthcare costs.

What equation relates private costs, external costs, and social costs?

$$\text{Private cost} + \text{External cost} = \text{Social costs}$$

What equation relates private benefits, external benefits, and social benefits?

$$\text{Private benefit} + \text{External benefit} = \text{Social benefits}$$

How are Marginal Private Cost ($MPC$) and Marginal Private Benefit ($MPB$) defined?

Marginal Private Cost ($MPC$) is the cost of the next unit produced or consumed, while Marginal Private Benefit ($MPB$) is the benefit derived from producing or consuming the next unit.

In this market failure diagram, what equilibrium condition determines the free-market outcome versus the socially optimum outcome?

The free-market equilibrium occurs where $MPC = MSB$ (at price $P_e$ and quantity $Q_e$), whereas the socially optimal equilibrium occurs where $MSB = MSC$ (at price $P_{opt}$ and quantity $Q_{opt}$).

Why does a free market fail in the presence of negative externalities of production?

Producers consider only their private costs ($MPC$) and ignore external costs, leading to an over-provision of the good at quantity $Q_e$ compared to the social optimum $Q_{opt}$, resulting in a welfare loss triangle.

In this diagram showing positive externalities of consumption, what determines the free-market equilibrium versus the socially optimal equilibrium?

The free-market equilibrium occurs where $MPB = MSC$ (at price $P_e$ and quantity $Q_e$), while the socially optimal equilibrium occurs where $MSB = MSC$ (at price $P_{opt}$ and quantity $Q_{opt}$).

Why does a free market fail in the presence of positive externalities of consumption?

Consumers consider only private benefits ($MPB$) and ignore external benefits, leading to an under-consumption of the good at quantity $Q_e$ compared to the social optimum $Q_{opt}$.

According to the provided table, what external costs are generated by iron ore extraction (mining)?

Soil erosion, loss of habitat for species, decrease in air quality, and chemical leakage into the water table.

What government interventions can address the negative externalities of iron ore mining, and what is a potential disadvantage?

Interventions include indirect taxation, legislation, regulation, and enforcement through fines. A key disadvantage is that decreasing external costs may reduce output, which could decrease economic growth.

According to the provided table, what external benefits are associated with leisure centres?

Healthy people require less state medical care, stress relief increases workplace productivity, older people maintain independence longer, improved memory and concentration raise productivity, and improved relationships help others be more productive.

What defining characteristics distinguish private goods from public goods?

Private goods are excludable and rivalrous, allowing private firms to profit. Public goods are non-excludable and non-rivalrous, preventing private firms from profiting and requiring government provision.

What is meant by non-excludability in the context of public goods?

The inability of private firms to exclude certain customers from using a product or service through the price mechanism (for example, streetlighting).

What is meant by non-rivalry in the context of public goods?

The inability of a product to be used up, meaning consumption by one person does not reduce availability for others, so there is no competitive rivalry to drive up prices and generate profits.

What is the 'free rider' problem in public goods?

A situation where consumers realize they can access and benefit from a good without paying for it, leading paying customers to stop paying and causing private firms to stop providing the good altogether.

How do public goods differ from merit goods regarding market provision?

Public goods suffer from missing markets where private firms will not provide them at all, whereas merit goods (such as healthcare) are provided by private firms for profit but are under-provided because high prices make them unaffordable for some.

What is the difference between symmetric information and asymmetric information?

Symmetric information occurs when buyers and sellers have the exact same level of information. Asymmetric information occurs when buyers and sellers have different levels of information, distorting market prices and quantities.

How did information gaps contribute to the 2008 financial crisis?

Financial industry experts were not fully aware of the complexity of the financial products being developed and marketed, leading to asymmetric information that was a primary cause of the market failure.