1.3 - Market failure

• What determines the allocation of scarce resources in a free market?

  The price mechanism
• What are considered scarce resources?

  Land, labour, capital, and enterprise
• What is market failure?

  A less than optimal allocation of resources
• What can result from market failure?

  Over-provision or under-provision of goods
• What leads to a lack of allocative efficiency?

  Misallocation of resources
• What are the sources of market failure?

  • Existence of externalities
  • Under-provision of public goods
  • Information gaps in markets
• What are externalities?

  External impacts on third parties not involved
• What types of externalities exist?

  Positive and negative externalities
• What is a positive externality of consumption?

  Positive impact on third parties from consumption
• What is a negative externality of consumption?

  Negative impact on third parties from consumption
• What is a negative externality of production?

  Negative impact on third parties from production
• How does the price mechanism in a free market treat externalities?

  It ignores these externalities
• What are public goods?

  Goods beneficial to society but under-provided
• Why are public goods under-provided by free markets?

  Less opportunity for sellers to profit
• What are information gaps in markets?

  Differences in information between buyers and sellers
• What is asymmetric information?

  Unequal information levels between buyers and sellers
• How does asymmetric information affect market outcomes?

  It distorts prices and quantities
• What was a primary cause of the 2008 financial crisis?

  Information gaps in the financial market
• What are external costs?

  Social costs greater than private costs
• What is the formula for social costs?

  Private cost + external cost
• What are external benefits?

  Social benefits greater than private benefits
• What is the formula for social benefits?

  Private benefit + external benefit
• What is marginal analysis in economics?

  It considers the cost or benefit of the next unit
• What is marginal private cost (MPC)?

  Cost of the next unit produced or consumed
• What is marginal private benefit (MPB)?

  Benefit from the next unit produced or consumed
• What does the gap between Qopt and Qe indicate?

  Over-provision of goods/services
• What does the equilibrium where MSB = MSC indicate?

  No market failure
• What does the pink triangle represent?

  Welfare loss to society
• What can government intervention do in cases of market failure?

  Make the market more socially efficient
• What are positive externalities of consumption?

  Benefits created during consumption of goods
• What does under-consumption of goods/services indicate?

  Only private benefits are considered
• What is the gap between Qe and Qopt indicative of?

  Under-consumption of goods/services
• What can government intervention do to correct under-consumption?

  Increase provision or subsidize goods/services
• What is the free rider problem?

  Customers access goods without paying
• What happens if firms stop providing public goods?

  They become under-provided in society
• What is the difference between public goods and merit goods?

  Public goods are not provided by private firms
• What is symmetric information?

  Equal information levels among buyers and sellers
• What is the impact of asymmetric information on market prices?

  It distorts socially optimal prices
• How does asymmetric information affect the used car market?

  Sellers know more than buyers
• What happens to goods with dangerous side effects if buyers are informed?

  They would be sold in lower quantities