1.3 market failure

• What is market failure?

  Market failure occurs when the market fails to allocate scarce resources efficiently.
• What is the consequence of market failure?

  It causes 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?

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

  Education and healthcare have positive externalities.
• Give an example of a negative externality.

  Cars and cigarettes have negative externalities.
• What are public goods?

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

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

  The free-rider problem occurs when individuals cannot be charged for the provision of a non-excludable good.
• Why won't private sector producers provide public goods?

  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.
• What is asymmetric information?

  Asymmetric information is when one party has superior knowledge compared to another.
• How does advertising contribute to information gaps?

  Advertising is designed to change consumer attitudes, which can lead to information gaps.
• What is the impact of information gaps on market efficiency?

  Information gaps lead to a misallocation of resources, preventing consumers from maximizing their welfare.
• What are some examples of information gaps?

  Examples include drugs, pensions, and financial services.
• What is the role of government intervention in market failure?

  The government intervenes to ensure the market considers external costs and benefits.
• What are the methods of government intervention to address market failure?

  • Indirect taxes and subsidies
  • Tradable pollution permits
  • Provision of the good
  • Provision of information
  • Regulation
• What is the purpose of indirect taxes and subsidies?

  They help to internalise externalities, moving production closer to the social optimum position.
• What are tradable pollution permits?

  They allow firms to produce up to a certain amount of pollution and can be traded among firms.
• Why might the government provide a good through taxation?

  When social benefits are very high, the government may decide to provide the good.
• How can the government provide information to address externalities?

  The government can provide information to help people make informed decisions and acknowledge external costs.
• What is regulation in the context of market failure?

  Regulation could limit consumption of goods with negative externalities.
• What are the two key characteristics of public goods?

  • Non-rivalry
  • Non-excludable
• Why are there very few examples of pure public goods?

  Pure public goods are non-rivalry and non-excludable, which is rare.
• What is the definition of a free rider?

  A free rider is someone who receives the benefits of a good without paying for it.
• What happens if the provision of public goods is left to the market mechanism?

  The market would fail to provide public goods effectively.
• What is the impact of technology on information gaps?

  Increases in technology mean information gaps are on the decline.
• How do information gaps lead to market failure?

  They cause a misallocation of resources, preventing rational decisions.
• 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.