market failure and government intervention

• market failure

  when the price mechanism leads to a misallocation of resources
• negative externalities costs on third-parties outside the price mechanism
• minimum price

  the lowest price suppliers of a good can sell for
• minimum price on a diagram

  because of minimum price firms cant decrease price to get rid of their excess supply

  
• firearm act

  1997
• regulation

  when the Government makes changes to the law to address market failure
• private costs

  a cost to a producer or consumer inside the price mechanism
• tradable pollution permits

  permits which allow firms to pollute up to a certain limit

  these permits can be traded between firms
• positive externalities

  benefits which affect third parties outside the price mechanism
• welfare

  social benefit - social cost
• subsidy

  a grant given by the governement to a firm to increase supply
• maximum price

  the highest price suppliers of a good can sell for
• maximum price diagram

  the maximum price , pmax, prevents the price from rising above pmax. So the market is stuck in a disequilibrium at pmax, creating excess demand.

  
• private benefit

  a benefit to a consumer inside the price mechanism
• non-excludable

  cant exclude others from consuming it
• non-rival

  your consumption of the good does not prevent anyone else from using it
• free rider problem

  consumer wont demand a public good, because they can just wait for someone else to buy and will use it for free. Producers will not supply a public good because consumers will just use it for free , so producers cannot make profit

  so public goods are underprovided by the free market
• how is the free rider problem solved

  the government taxes people using direct and indirect tax. Then puts all the tax revenue together and uses the money to buy public goods
• state provision

  when a government provides a good
• public goods

  goods that are non-excludable and non-rival
• two types of information gaps

  • incomplete information
  • asymmetric information
• incomplete information

  when someone doesn't have full information about the benefits or costs of their decisions
• how does the government intervene in education to prevent the market failure caused by information gaps?

  • regulations e.g legally requiring students to stay in education till age 18
  • information provision e.g providing information, such as advertising, on the benefits of education
  • subsidies e.g subsiding tuition
• asymmetric information

  when one party knows more than another party in transaction
• symmetric information

  all parties know just as much as each other
• information gaps

  when consumers or producers lack the information needed to make an informned decision
• public secter

  organisations that are owned and controlled by the government
• private secter

  the part of the economy that is run by individuals and companies often for profit
• Asymmetric information can be linked with the principal-agent problem. This is when the agent makes decisions for the principal, but the agent is inclined to act in their own interests, rather than those of the principal. For example, shareholders and managers have different objectives which might conflict. Managers might choose to make a personal gain, rather than maximise the dividends of the shareholders
• socially efficient equilibrium

  where MSC=MSB and society's welfare is maximised