micro chapter 5.1-5.3 the market mechanism and market failure

the 4 functions of prices

the signalling function; the incentive function; the rationing function; the allocative function

the signalling function of prices

prices provide information to buyers and sellers, which allows buyers and sellers to plan and coordinate their economic activities

the incentive function of prices, + examples

prices create incentives for people to alter their economic behaviour - e.g. a higher price creates an incentive for firms to supply more of a good or service; e.g. prices of one fruit relative to another fruit creates incentives for people to alter their economic behaviour

how the incentive function works in the labour market in relation to wages

rising wages create the incentive for people to acquire new skills and supply their labour services; whilst falling wages reduces theses incentives

the rationing function of prices

rising prices rations demand for a product, and so distributes scarce goods to those consumers who value them most highly

the incentive function prices shown on a supply and demand diagram when there is a price rise

shown by an extension of supply along the market supply curve

how does the rationing function of prices work to get rid of excess demand

the price rises to get rid of excess demand - this price rise reflects the strength of consumer preferences and consumer's ability to pay

the rationing function of prices shown on a supply and demand curve

shown by a contraction of demand along the demand curve, and demand contracts until excess demand is eliminated

how does the rationing function of prices work in the labour market in relation to wages

rising wages ration firms demand for labour

the allocative function of prices

changing relative prices allocates scarce resources away from markets exhibiting excess supply, where prices are too high, and into markets in which there is excess demand, where prices are too low

market failure

when the market mechanism leads to a misallocation of resources in the economy, either completely failing to provide a good or service, or providing the wrong quantity

complete market failure

when the market simply does not exist

partial market failure

when the market functions, but produces the wrong quantity of a good or service e.g. the good or service may be provided too cheaply, and so it is over produced or over consumed

missing market

a situation in which there is no market because the functions of prices have broken down

market failure that may occur as a result of a monopoly

a good may be too expensive, and so it may be under produced or under consumed

a private good

a good which is excludable and rival e.g. an orange

excludability

the ability of the owner of a good or service to prevent others from enjoying the benefits of consuming it without paying for it

rivalry

when one person consumes the good or service, the quantity available to others diminishes

a public good

a good which is non-excludable and non-rival e.g. a radio programme

how public goods can lead to market failure

it is impossible to exclude free riders, and so it may be impossible to collect enough revenue to cover costs; because if too many people to decide to 'free ride', profits cannot be made, and the incentive to provide the good or service through the market disappears = the market fails to provide it

the example of national defence as a public good

national defence is non-rival because receiving the benefits of it doesn't reduce the benefits available to others; and it's non-excludable because providing the benefits for one means providing the benefits for all

what does consumption of consumer goods result in

increased economic welfare; because consumer goods yield usefulness or utility, and some sometimes pleasure and satisfaction

an economic 'bad'

the opposite of a good, yielding disutility, dissatisfaction, or displeasure; and consumption of it decreases economic welfare

the free rider problem resulting from an economic 'bad'

payment for removing the 'bad', such as rubbish, can be avoided by dumping the bad in a public place or on someone else's property

a quasi-public good

a good which is partially excludable or partially rival

how have roads changed from being pure public goods to quasi public goods

due to technological change, which has made it feasible for the government or local authorities to use electronic pricing to charge all motorists