1.5 market failure and govt intervention

• why do private costs determine about the good produced

  • how much of the good should be produced
  • the market price of the good
• equation for the total social cost

  social cost = private costs + external costs
• how would you calculate the external costs from a graph

  the vertical distance between the marginal social cost(MSC) line and the marginal private cost(MPC) line
• do the MPC and MSC lines move parallel to each other

  No, both line diverge from each other as external costs increase disproportionally to output
• graph showing external costs of production in a market, labelling the area of welfare

  When negative externalities are present MSC > MPC, which results in welfare loss. The goods are overproduced by Qe-Q1

  
• graph showing external benefits of production in a market, labelling area of welfare gain

  When positive externalities are present, MSB > MPB, which results in welfare gain. The goods are underbought by Q1 - Qe

  
• externality

  cost or benefit to a third party member outside the market transaction
• where on a graph is the socially optimal point in a market

  where MSC = MSB
• market failure

  occurs when the free market fails to allocate resources to the socially optimal level of output
• difference between public and private goods

  PUBLIC - Non excludable and non rival

  PRIVATE - Excludable and rival
• why are public goods underprovided in a free market

  people who don't pay for the good receive the same benefits. It is underprovided by the private sector as there is no potential for profit
• link between market failure and perfect information

  rarely do both parties of a market transaction have perfect information and so there is usually a misallocation of resources, hence market failure
• why do govts often intervene in free markets

  intervene to correct market failure
• 3 examples of govt intervention

  • regulation
  • indirect taxes
  • subsidies
• 2 different types of indirect taxes

  • ad valorem tax
  • specific tax
• what type of indirect tax is represented on this graph

  ad valorem tax

  
• how do indirect taxes reduce the quantity of demerit goods consumed

  firms that have to pay the taxes pass them onto consumes in the form of higher prices , thus reducing the quantity demanded
• subsidy

  payment from the government to firms in order to lower their costs of production and encourage production
• would the govt subsidise alcohol products or education and why

  education, because this is a merit good and so it would encourage learning and improve the quality of the labour force
• which way would a subsidy shift the supply curve

  to the right (as it reduces the cost of production, which encourages firms to produce more)
• how could a subsidy potentially become a source of govt failure

  it could distort price signals by distorting the free market mechanism
• example of unintended consequences when implementing govt policies

  policy could be expensive to implement