market mechanism, market failure

• What are the three functions of prices in a market economy?

  • Rationing: Prices allocate goods and services to those willing to pay.
  • Incentive: Prices motivate producers to supply more or less of a good.
  • Signalling: Prices signal to producers and consumers about the demand or supply of a good.
• What is the rationing function of prices?

  Prices act as a mechanism to allocate scarce goods to those willing and able to pay, reducing demand when the supply is limited.
• What is the incentive function of prices?

  Prices create incentives for producers to increase supply when prices are high and reduce supply when prices are low. Similarly, high prices encourage consumers to reduce demand and low prices to increase demand.
• What is the signalling function of prices?

  Prices send signals to producers and consumers about the relative scarcity or abundance of goods. Rising prices signal higher demand or lower supply, while falling prices signal the opposite.
• What are the advantages of the price mechanism?

  • Efficient allocation of resources.
  • Flexibility in responding to changes in supply or demand.
  • Incentives for innovation and investment.
  • Decentralized decision-making.
• What are the disadvantages of the price mechanism?

  • Inequality in income and wealth distribution.
  • Externalities (e.g., pollution or benefits not captured by the price).
  • Market failure due to imperfect information or market power.
• What is the impersonal nature of the price mechanism?

  The price mechanism operates without regard to personal relationships, ethics, or social values. It is driven purely by supply and demand.
• What are some examples of introducing the price mechanism in new areas?

  • Market for blood donations.
  • Charging for access to public goods (e.g., clean water, air).
  • Introducing market prices for natural resources.
• What is market failure?

  Market failure occurs when the allocation of resources by the free market leads to an inefficient outcome, causing a net welfare loss.
• What is the difference between complete market failure and partial market failure?

  • Complete Market Failure: No market exists for a good or service (e.g., public goods).
  • Partial Market Failure: A market exists, but it does not allocate resources efficiently (e.g., externalities).
• What are public goods?

  Public goods are non-rival (one person's use does not reduce availability for others) and non-excludable (it is impossible to exclude others from using them).

  • Example: National defense, clean air.
• What is the free-rider problem?

  It occurs when individuals benefit from a good or service without paying for it, leading to underproduction of the good or service.
• What is the tragedy of the commons?

  The tragedy of the commons occurs when individuals overuse and deplete a shared resource because they act in their own self-interest, ignoring the long-term collective harm.

  • Example: Overfishing, deforestation.
• How do externalities lead to market failure?

  • Externalities occur when the private costs or benefits of an activity differ from the social costs or benefits, causing overproduction (negative externalities) or underproduction (positive externalities).
• What is the effect of negative externalities on production?

  Negative externalities lead to overproduction, as the social cost exceeds the private cost, causing firms to produce more than is socially optimal.
• What is the effect of positive externalities on production?

  Positive externalities lead to underproduction, as the social benefit exceeds the private benefit, causing firms to produce less than is socially optimal.
• What are merit goods?

  • Merit goods are goods that are considered beneficial to individuals and society, but are often under-consumed because individuals may undervalue them.
  • Example: Education, healthcare.
• What are demerit goods?

  Demerit goods are goods that are considered harmful to individuals and society and are often over-consumed due to addiction or lack of awareness.

  • Example: Tobacco, alcohol.
• How does imperfect information cause market failure?

  • Imperfect information leads to misinformed decisions by consumers and producers, resulting in over-consumption or under-consumption of goods and services.
  • Example: Consumers may underestimate the health risks of smoking.
• What are the effects of monopoly power on market efficiency?

  Monopolies reduce market competition, leading to higher prices, reduced output, and inefficiency, causing a welfare loss in the market.
• Why is government intervention needed in markets?

  Government intervention is needed to correct market failure, address inequality, provide public goods, and regulate externalities.
• What are the methods of government intervention?

  • Indirect taxes (e.g., carbon taxes to reduce pollution).
  • Subsidies (e.g., subsidies for renewable energy).
  • Price controls (e.g., price floors, price ceilings).
  • State provision (e.g., government-provided healthcare).

  1. Regulation (e.g., environmental regulations).
• What are the objectives of government intervention in a mixed economy?

  • Correct market failure (e.g., externalities, public goods).
  • Redistribute income and wealth (e.g., progressive taxation).
  • Promote economic stability (e.g., reducing unemployment, controlling inflation).
  • Ensure social justice (e.g., providing basic welfare services).
• What is government failure?

  Government failure occurs when government intervention leads to a misallocation of resources, causing inefficiency and potentially worsening market outcomes.
• What causes government failure?

  • Inadequate information: Governments may not have accurate data to make informed decisions.
  • Conflicting objectives: Different policies may work at cross purposes.
  • Administrative costs: Government regulation and oversight may create inefficiencies.
  • Unintended consequences: Policies may have unintended negative side effects.
• What is the difference between positive and negative externalities?

  • Negative Externalities: Occur when the costs of production or consumption are not borne by the producer/consumer but by third parties.
  • Example: Pollution from a factory affecting nearby residents.
  • Positive Externalities: Occur when the benefits of production or consumption are enjoyed by third parties.
  • Example: A vaccinated individual reducing the spread of disease.
• How do externalities cause a misallocation of resources?

  • Negative Externalities: Producers do not account for the social costs of their actions, leading to overproduction of harmful goods.
  • Positive Externalities: Producers do not capture all of the social benefits, leading to underproduction of beneficial goods.
• What is the social cost of negative externalities?

  The social cost is the total cost of an activity to society, including both the private costs borne by the producer and the external costs imposed on others.

  • Example: Pollution from factories increases the health costs to society.
• What are the social benefits of positive externalities?

  The social benefits are the total benefits to society from an activity, including both the private benefits to the consumer and the external benefits enjoyed by others.

  • Example: An individual's education increases productivity and benefits society through higher tax revenue and lower unemployment.
• What is a Pigovian tax?

  A Pigovian tax is a tax imposed on a good or service that generates negative externalities, with the goal of reducing consumption and internalizing the external costs.

  • Example: A carbon tax on emissions from fossil fuels.
• What is a subsidy in economics?

  A subsidy is a financial support provided by the government to encourage the production or consumption of a good or service that generates positive externalities.

  • Example: Government subsidies for renewable energy sources like wind or solar power.
• What are merit goods and why are they under-provided in a free market?

  • Merit goods are those that society deems to have intrinsic value and social benefits, such as education and healthcare.
  • They are under-provided because individuals may under-estimate their benefits or lack access due to income constraints, leading to market failure.
• What are demerit goods and why are they over-consumed in a free market?

  • Demerit goods are goods that are considered harmful to individuals or society, such as cigarettes and alcohol.
  • They are over-consumed because individuals may be unaware of the harm or are influenced by addiction, leading to a misallocation of resources.
• How can government intervention address externalities?

  • Taxes: To reduce negative externalities (e.g., carbon tax).
  • Subsidies: To encourage positive externalities (e.g., subsidies for vaccines).
  • Regulation: Set limits or bans on harmful activities (e.g., pollution regulations).
  • Public Provision: Government provision of goods that create positive externalities (e.g., public healthcare, education).
• What is government intervention in a mixed economy?

  • Government intervention is the involvement of the government in the economy to correct market failures, redistribute resources, and provide public goods.
  • Example: Provision of public healthcare, regulation of pollution, taxation to fund welfare programs.
• What are the objectives of government intervention in the economy?

  • Correct market failure (e.g., addressing externalities, providing public goods).
  • Promote equity (e.g., redistribution of income).
  • Economic stability (e.g., reducing unemployment, controlling inflation).
  • Promote economic growth (e.g., policies to increase investment).
• What are indirect taxes and how do they address market failure?

  • Indirect taxes are taxes on goods and services (e.g., VAT, excise taxes) that can be used to reduce the consumption of goods with negative externalities.
  • Example: Excise tax on cigarettes to reduce smoking.
• What are the types of government regulation?

  • Price controls (e.g., minimum wages, rent controls).
  • Health and safety regulations (e.g., standards for workplace safety).
  • Environmental regulations (e.g., pollution limits).
  • Competition laws (e.g., anti-trust laws to prevent monopolies).
• What is price control and why is it implemented?

  • Price control is a government-imposed limit on the price of a good or service to prevent prices from rising too high or falling too low.
  • Price floors (e.g., minimum wage) and price ceilings (e.g., rent controls).
• What are the advantages and disadvantages of government intervention?

  Advantages:

  • Correcting market failures (e.g., reducing pollution).
  • Redistributing wealth for fairness (e.g., social welfare).
  • Promoting social justice (e.g., providing public healthcare).

  Disadvantages:

  • Inefficiency (e.g., over-regulation or excessive bureaucracy).
  • Unintended consequences (e.g., government failure, higher taxes).
  • Regulatory capture (e.g., businesses influencing regulators).