3.1.8 The market mechanism, market failure and government in intervention in markets

What is the rationing function?

Increasing prices rations demand to those most able to afford a good or service

What is the signalling function?

Prices provide important information to market participants

What is the incentive function?

The prices create incentives for market participants to change their actions

What is the allocative function?

Acts to divert resources to where returns can be maximised

What is market failure?

When the free market leads to a misallocation of resources in an economy

What is complete market failure?

When the free market fails to create a market for a good or service, also referred to as a missing market

What is a partial market failure?

When a market for a good or service exists but it is consumed or produced in quantities that do not maximise economic welfare

What is a public good?

. A good that is non-excludable and non-rival in consumption

. Is a prime example of complete market failure

What does non-excludable mean?

Where it is not possible to prevent non-paying customers from consuming a good

What does non-rival mean?

Where one person’s enjoyment of a good does not diminish another person’s enjoyment of the good

What is a private good?

A good that is rival and excludable in consumption

What is a Quasi-public good?

.A good that exhibits some,but not all, of the characteristics of a public good

. i.e it is partially non-exculdable and/or partially non-rival

What is an externality?

A knock-on effect of an economic transaction upon third parties

What is a positive externality?

A positive knock-on effect of an economic transaction upon third parties, also known as an external benefit

What is a private cost?

The cost to an individual producer involved in a market transaction

What is a social benefit?

The total of private benefit plus external benefit of an economic transaction

What is a negative externality?

A negative knock-on effect of an economic transaction upon third parties, also known as an external cost

What is a social cost?

The total of private cost plus external cost of an economic transaction

What is information failure?

A source of market failure where market participants do not have enough information to be able to make effective judgements about the “correct” levels of consumption or production of a good

What is a private benefit?

The benefit to an individual consumer involved in a market transaction