Market Failure

• define a free market

  where buyers and sellers meet to exchange goods and services without government intervention
• how are resources allocated in a free market


  price mechanism- supply and demand freely determine price
• what are the 3 functions of price in a free market


  rationing

  incentive

  signalling
• define the incentive function 


  creates incentives for economic agents to change their behaviour
• define the rationing function 


  allocates scarce resources
• define the signalling function


  provides information for economic agents
• define a planned economy


  economic decisions are controlled by the government - limited free market
• define a market economy

  economic decisions guided by firms and individuals
• what are some disadvantages of the price mechanism 


  market solutions can sometimes lead to sub optimal outcomes. emotions are not considered in the transaction
• define market failure


  the misallocation (over or under) of resources by the market
• what are the 2 features of a public good 


  non-excludable

  non-rivalrous
• define non excludable


  consumers cannot be prevented from consumption
• define non rivalrous 


  consumption of the good doesn't affect the amount of good available on the market
• why are public goods supplied by the government

  free rider problem- if you cant prevent access then there is no incentive to pay
• what is a quasi public good 


  have some characteristics of non-excludability or non-rivalry

  e.g. public broadcasting - excludable but non rivalrous

  roads - non excludable but rivalrous
• define private costs 


  costs incurred by those taking the action
• define public costs 


  costs incurred by third parties as a result of an action
• what is a social cost / benefit

  private + external
• define a negative externality 


  divergence between private and social costs
• define private benefits


  benefits enjoyed by those doing the action
• define external benefits 


  benefits for third parties from others actions
• define a positive externality 


  difference between social and private
• define productive externalities 


  externalities generated by firms during the production process
• define consumption externalities 


  externalities generated in consuming a good
• give an example of positive production externalities

  building buses may reduce pollution
• give an example of positive consumption externalities 


  education makes a more productive workforce reducing social costs for everyone
• give an example of negative production externalities

  fossil fuel production causes pollution
• give an example of negative consumption externalities

  smoking can pollute, make others ill, put strain on NHS
• define MPC


  marginal private cost - private cost for a producer (supply side)
• define MSC


  marginal social cost - the external and private cost for the producer (supply side)
• define MPB


  marginal private benefit - private benefit for the consumer (demand side)
• define MSB


  marginal social benefit - private benefit for consumer + social benefit (demand side)
• what do negative externalities in production look like

  between Q1 and Q2 the MSC is greater than MSB so there is a net welfare loss. the optimum output is when MSB=MSC

  A) MSC

  B) MPC

  
• what do positive externalities in production look like on a graph

  producers don't realise what they are producing has positive externalities so under produce creating a deadweight welfare loss of the green triangle.

  A) MSC

  B) MPC

  
• what do negative externalities in consumption look like

  private benefits are greater than social benefits meaning the product is over consumed.

  A) MPB

  B) MSB

  
• what is deadweight welfare loss 


  the cost to society due to either over/under consumption/production
• what is a merit good 


  where MSB > MPB so can be underprovided by the market
• what is a demerit good

  a good where MPC > MSC so is over provided by the market e.g. cigarettes
• define property rights 


  the rights to ownership over a resource
• what are the key impacts of a lack of property rights

  the misuse of scarce resources e.g. pollution

  the overuse of common property resources e.g. over-fishing