LS17-LS19 Booklet

• market failure is where too much or little little of a good or service is consumed, compared to the socially optimum level of output, or when the price mechanism causes a inefficient allocation of resources
• External cost: a cost to the third party that is not involved in the transaction or consumption of a good/service
• External benefit: a benefit to the third party that is not involved in the transaction or consumption of a good/service
• Product R is an inferior good with no close substitutes. It is a complement to Product S. Product R has a:

  • negative income elasticity of demand
  • negative cross elasticity of demand
• consumer surplus = triangle
• Incentive: when price rise, producers have the incentive to boost production because higher profits can be earned
• Signalling: prices help to determine where and how resources should be allocated. If prices increase, this signals to the producer that demand has increased and they should increase production in order to fully profit maximise
• rationing: because resources are scarce and finite, not everyone is able to buy everything that they want. When demand is greater than supply, prices increase and so the good is rationed out to those who can afford to pay
• A good takes a long time to produce and is perishable - so it has an inelastic price elasticity of supply
• Types of market failure:

  • externalities
  • Under provision of public goods
  • information gap
• Externalities: is when the consumption and production of some goods/services provides costs/benefits to economic agents not involved in the transaction

  FOR EXAMPLE: negative effects of second hand smoking to those who didn’t buy or sell the product
• Under provision of public goods:

  Some goods tend to become under provided if provision was left solely to the private sector.

  As individuals cannot be excluded from enjoying these goods, many will not want to pay, leading to insufficient revenue being generated. This lack of financial incentive discourages private firms from producing or maintaining these goods. (links to free rider problem)
• Information gap:

  some markets have information problems between consumers and producers which results in an under or over consumption of the product

  FOR EXAMPLE: producers not telling consumers/workers certain things
• PERFECT information:

  When a buyer/seller has complete understanding of the quality and nature of a good or service
• SYMMETRIC information:

  when buyers/sellers have equal amounts of knowledge about a good/service
• IMPERFECT information:

  when a buyer/seller lacks a COMPLETE understanding of the quality and nature of a good or service
• ASYMMETRIC information:

  when a buyer/seller has more information about a good or service than the other party
• information gap:

  when either the buyer/seller doesn’t have enough access to information needed to make a fully informed decision
• free rider problem: a type of market failure that occurs because everybody is able to benefit from them
• free riders are a problem because while not paying for a good, they may continue to consume it. Therefore, the good is likely to be under provided or not provided at all
• Goods that are non excludable and non rivalrous are public goods
• consumers are able to free ride of public goods because they are able to benefit of the good without paying for it
• Too many free riders would cause the underprovision of public goods
• elastic demand diagram: demand line is nearly horizontal
• inelastic demand diagram: demand line is nearly vertical
• social benefits: private benefits + external benefits
• social cost: private cost + external cost
• The social optimum level of output occurs where all external benefits and external costs are accounted for
• if external BENEFITS are present, there will be a under production/consumption in a free market
• if external COSTS are present, there will be a over production/consumption in a free market
• law of diminishing marginal utility is when the satisfaction derived from one extra unit of a good decreases as consumption increases
• normative statements are subjective (opinions)
• positive statements can be proven true or false
• information gap between producer and consumer can be caused due to a lack of labelling
• in a free market, public goods are under provided due to the free rider problem
• merit goods = goods with external benefits
• scarcity leads to choice which leads to opportunity cost. scarcity leads to competition which leads to innovation