Booklet 6 - market failure

what is market failure

market failure occurs when the free market mechanism deoes not lead to an optimal allocation of recources

what are the types of market failure

• demerit goods

• merit goods

• information gaps

• public goods

• externalities

give me a positive and negative externality of Heathrow airport expansion

negative - air pollution, noise pollution, house loss

positive - decreased geographical limitations, creating jobs = multiplier effect, tourism increases

what is the formula for social cost

private cost + external cost

what is the formula for marginal social cost

marginal private cost + marginal external cost

what is the formula for social benefit

external benefit + private benefit

what is the formula for marginal social benefit

marginal private benefit + marginal external benefit

why is positive and negative externalities a form of market failure

allocative inefficiency - the market fails to provide the right quantities of goods with positvie and negative externalities.

would negative externalities be over or underconsumed

demerit goods such as alchohol would be overpoduced

would merit goods be over or underconsumed

in a free market merit goods are under consumed = schools, healthcare ect is too expensive

exlpain the negative externality of production - noise pollution (DRAW DIAGRAM TOO)

• the free market level of output of air travel is at Q1, where only marginal private cost and benefits to air travel provides is considered

• However air travel causes a marginal external cost to third parties

• some examples are noise pollution, road congestion around the airport and air pollution

• MPC + MEC + MSC this is the true cost to society of air travel.

• MEC is taken into account, the socially optimum level of air travel is Q*

• Air transport is being over produced Q1 to Q*, this shows the amount of market faliure.

• Area ABC represents deadweight welfare loss to society. This is the improvement in welfare for society that would take place if output of air travel was reduced to Q*

explain the positive externality of consumtion - education

• the free market level of output of education is Q1, where marginal private cost and benefit to students are considered

• however education has a marginal external benefit to third parties

• examples are better workers, economic growth, better international competitiveness and more tax revenue for the government to spend on public services to all

• MPB + MEB = marginal social benefit. This is the true benefit to society of education

• when MEB is taken into account, the socially optimum output of education is Q*

• Ecucation is under consumed from Q1 to Q*. This shows the amount of market failure

• Area ABC is represents the deadweight welfare loss to society. This is an improvement in the welfare for society that would only take place if output of education in Q*

define non rivalrous goods

a situation in which one persons consumtion of a good does not prevent others from consuming it as well

define non exludabilty

in which it is not possible to provide a product to one person without allowing others to consume it as well

what is the free rider problem

market failure as a result of no incentives for the production of goods as there is no profit.

Information Gaps

when one or both economic agents involved in the transaction does not have full or accurate information

define assymetric information

a situation in which some participants in a market have better information then others about the market conditions