1.3

• What is market failure?

  Market failure occurs when the market fails to allocate scarce resources efficiently, causing a loss in social welfare.
• What are the three main types of market failure?

  • Externalities
  • Under-provision of public goods
  • Information gaps
• What is an externality?

  An externality is the cost or benefit a third party receives from an economic transaction outside of the market mechanism.
• How do externalities affect resource allocation?

  Externalities lead to the over or under-production of goods, meaning resources aren’t allocated efficiently.
• Give an example of a negative externality.


  Cars and cigarettes have negative externalities.
• Give an example of a positive externality.


  Education and healthcare have positive externalities.
• What are public goods?

  Public goods are non-rivalry and non-excludable, meaning they are underprovided by the private sector due to the free-rider problem.
• What is a good example of a public good?

  Streetlights are a good example of a public good.
• What is the free-rider problem?

  The free-rider problem states that you cannot charge an individual a price for the provision of a non-excludable good because someone else will gain the benefit from it without paying.

  
• Why will private sector producers not provide public goods?

  Private sector producers will not provide public goods because they cannot be sure of making a profit due to the non-excludability of public goods.

  
• What is symmetric information?

  Symmetric information occurs where buyers and sellers have potential access to the same information; this is perfect information.
• What is asymmetric information?


  Asymmetric information is when one party has superior knowledge compared to another, usually where the seller has more information than the buyer.
• How does advertising contribute to information gaps?

  Most advertising leads to information gaps as it is designed to change attitudes of consumers to encourage them to buy the good.
• What are the consequences of information gaps in the market?

  Information gaps lead to market failure as there is a misallocation of resources because people do not buy things that maximize their welfare.

  
• What is a merit good?

  A merit good is a good with external benefits, where the benefit to society is greater than the benefit to the individual.
• What is a demerit good?

  A demerit good is a good with external costs, where the cost to society is greater than the cost to the individual.
• What are the private, social, and external costs and benefits?

  • Private costs/benefits: Costs/benefits to the individual participating in the economic activity.
  • Social costs/benefits: Costs/benefits of the activity to society as a whole.
  • External costs/benefits: Costs/benefits to a third party not involved in the economic activity.

  
• What is the marginal private benefit (MPB)?


  The marginal private benefit (MPB) is the extra satisfaction gained by the individual from consuming one more of a good.
• What is the marginal social benefit (MSB)?


  The marginal social benefit (MSB) is the extra gain to society from the consumption of one more good.
• What is the marginal private cost (MPC)?


  The marginal private cost (MPC) is the extra cost to the individual from producing one more of the good.
• How do negative production externalities affect market equilibrium?

  Negative production externalities occur when social costs are greater than private costs, leading to a loss of welfare.
• What happens when the market produces where MPB=MPC?

  When the market produces where MPB=MPC, it ignores the external costs involved in producing a good.
• What is the social optimum position in terms of production?

  The social optimum position occurs where MSB=MSC.
• How do positive consumption externalities affect resource allocation?

  Positive consumption externalities occur when social benefits are greater than social costs, leading to underproduction of goods.
• What is the role of government intervention in addressing externalities?

  The government can intervene through indirect taxes, subsidies, tradable pollution permits, provision of goods, provision of information, and regulation.

  
• What is one method the government uses to internalize externalities?

  Indirect taxes can be put on goods with negative externalities.
• What is the purpose of tradable pollution permits?

  Tradable pollution permits allow firms to produce up to a certain amount of pollution and can be traded among firms to reduce total pollution levels.
• Why might the government provide public goods?

  The government may provide public goods when social benefits are very high, such as in healthcare and education.
• How does the government provide information to address externalities?

  The government can provide information to help people make informed decisions and acknowledge external costs.
• What are the two key characteristics of public goods?

  Public goods are non-rivalry and non-excludable.
• Why are there very few examples of pure public goods?

  There are very few examples of pure public goods because they are both non-rivalry and non-excludable.
• What is the impact of technology on information gaps?

  Increases in technology mean information gaps are on the decline as people can get more information.
• What is moral hazard in the context of information gaps?

  Moral hazard occurs when suppliers have more information than consumers and abuse their customers for their own benefit.
• How do information gaps lead to market failure?

  Information gaps lead to market failure as there is a misallocation of resources because people do not buy things that maximize their welfare.

  
• What are some examples of information gaps?

  • Drugs, where users do not see the long-term problems.
  • Pensions, where young people do not see the long-term benefits.
  • Financial services, where suppliers have more information than consumers.