8. The Market Mechanism, Market Failure & Government Intervention (AQA A Level Economics): Flashcards

It leads to an efficient allocation of resources, as markets adapt quickly to changes.

False.

The price mechanism leads to the under-provision of public goods, causing market failure.

Market failure occurs when there is a less than optimum allocation of resources from the point of view of society.

Market failure involves either the over-provision or under-provision of goods and services.

Complete market failure occurs when there is a missing market, so the market does not supply a product at all despite society demanding it.

True.

Most are partial market failures, which involve a deadweight loss to society rather than a missing market.

Partial market failure occurs where the market exists but does not provide resources in the optimum quantities.

A complete market failure occurs when there is a missing market.

A public good such as national defence, which the free market fails to supply at all.

An externality is an external impact on a third party not involved in the economic transaction between the buyer and seller.

False.

Merit goods are under-provided by the free market, even though they are beneficial to consumers and society.

Imperfect information is when buyers and sellers have different levels of information in a market.

The three market imperfections are imperfect information, monopoly power and factor immobility.

False.

Public goods would be under-provided by a free market, as firms lack the incentive to supply them.

A public good is a good that is non-excludable and non-rivalrous, so it is not provided by private firms.

A private good is rival and excludable, which allows firms to generate profits from it.

A private good is a good that is rival and excludable, allowing firms to charge for it and generate profits.

False.

A non-rivalrous good is one where one person consuming it does not prevent another from consuming it.

The free-rider problem is when consumers access a good without paying, so paying customers stop and the good becomes under-provided.

A public good is non-excludable, meaning anyone can access it without having to pay.

It leads to a missing market and a complete market failure, as the good becomes under-provided.

A quasi-public good is a non-pure public good that has characteristics of both public and private goods.

True.

Technology such as subscription services can make once non-excludable goods excludable.

Unlike public goods, common-pool resources are rivalrous in consumption.

A motorway, which can be made excludable through the use of tolls.

False.

Governments usually provide public goods, but the quantity may be less than the socially optimal level.

An external cost occurs when the social costs of an economic transaction are greater than the private costs.

Private cost + external cost = social cost.

A private cost is what the producer actually pays to produce a good or service.

True.

Firms consider only private costs, not external costs, so they over-produce, causing market failure.

A negative externality of production is a negative external impact on a third party caused by producer supply.

In a negative externality of production, the marginal social cost is greater than the marginal private cost.

Air pollution generated when producing electricity, which harms local communities.

Deadweight loss is the loss of welfare to society at outputs beyond the social optimum, where marginal social cost exceeds marginal social benefit.

True.

Consumers ignore external costs, so goods such as cigarettes are over-consumed.

Externalities occur when there is an external impact on a third party not involved in the transaction.

Two demand curves are shown, because the externality is on the consumer (demand) side of the market.

True.

At the free-market private optimum, MPB = MSC, causing over-consumption relative to the social optimum.

A positive externality of production is a positive external impact on a third party caused by producer supply.

Producers consider only private benefits, not external benefits, so the good is under-provided.

True.

Only private benefits are considered, so the market under-provides the good, causing market failure.

An external benefit occurs when the social benefits of an economic transaction are greater than the private benefits.

Producing honey increases pollination for other farmers, which is a positive externality of production.

Honey production increases the number of bees and therefore pollination for other food producers.

A positive externality of consumption is a positive external impact on a third party caused by consumer demand.

False.

They are under-consumed, because consumers ignore the external benefits to third parties.

Vaccinations, which protect others by preventing the spread of disease, are a positive externality of consumption.

The MPB is less than the MSB, so the good is under-consumed relative to the social optimum.

True.

A subsidy encourages consumption towards the social optimum, reducing the welfare loss.

The social optimum is the allocatively efficient equilibrium where marginal social benefit equals marginal social cost.

A common pool resource is a natural resource over which no private ownership exists; it is non-excludable but rivalrous in consumption.

Both are non-excludable, but a common pool resource is rivalrous whereas a public good is non-rivalrous.

The tragedy of the commons occurs when common pool resources are used in an unsustainable way, leading to their depletion.

False.

There is no private ownership, as it is costly and inefficient to exclude other producers.

Common pool resources are non-excludable but rivalrous in consumption.

Oceans (especially international waters); rainforests, communal grazing land and rivers are also examples.

True.

Garrett Hardin described the tragedy of the commons in 1968.

Property rights define the ownership of a resource and set out how it can be used.

They give the owner a strong incentive to manage the resource sustainably, internalising the externality.

Granting property rights forces the producer to internalise the negative externality.

The three problems are equity, divisibility and enforcement.

True.

The Darién Gap rainforest is over-exploited by illegal loggers acting in self-interest.

Merit goods are products that are beneficial for society but are under-provided by the free market because consumers do not fully recognise their private or external benefits.

Consumers under-consume merit goods because they do not fully recognise the private or external benefits of consumption.

True.

Consumers over-consume demerit goods because they fail to consider the external costs of consumption.

At the free-market equilibrium, merit goods are under-consumed because consumers ignore the external benefits of consumption.

Demerit goods are products that have harmful impacts on consumers or society and are over-provided by the free market.

Governments often subsidise merit goods to lower their price and increase the quantity demanded.

False.

Not all goods that generate externalities are merit or demerit goods; this is a common misconception.

The over-consumption of demerit goods occurs because the social costs of consumption outweigh the private costs.

A value judgement is a subjective opinion, based on personal or societal values, used to decide whether a good is a merit or demerit good.

With imperfect information, consumers are ill-informed about the harmful consequences, so demand and consumption exceed the socially desirable level.

True.

The optimal allocation of resources for society occurs where MSB = MSC.

Education is a common merit good, while alcohol is a common demerit good.

They cause partial market failure, because the market still provides the good but at the wrong quantity.

Imperfect information is when buyers and/or sellers lack all the information, or have inaccurate information, needed to make an informed decision.

Symmetric information exists when buyers and sellers have the same level of information about a good or service.

True.

A firm controlling over 25% of the market share can act as a monopoly and exert market power.

A pure monopoly exists when there is only one producer in the market.

Market power is a firm's ability to influence and control the conditions in a market, particularly price and output.

A monopoly restricts output and charges a higher price, causing allocative inefficiency and a misallocation of scarce resources.

False.

Enterprise is generally very mobile because the skills involved can be applied across almost every industry.

Factor immobility occurs when factors of production cannot easily be reallocated to alternative uses.

Structural unemployment can arise when labour is immobile and cannot move to where new jobs are created.

Geographical immobility is difficulty moving between areas, while occupational immobility is difficulty moving between job sectors.

True.

If buyers were fully aware of the dangers they would buy less, so these goods are over-provided by the market.

Asymmetric information exists when one party in a transaction has more or better information than the other.

Land is often immobile due to climate conditions, for example certain crops cannot be grown in some climates.

A mixed economy is one in which resources are allocated by both the market and varying degrees of government intervention.

A main reason is to correct market failure, where resources are allocated less than optimally from society's point of view.

True.

Intervention seeks a more equitable distribution of income and wealth to reduce poverty.

One of the main reasons governments intervene in markets is to correct market failure.

A market-based policy involves the government acting to affect the conditions of supply or demand, and therefore price and output, such as a subsidy.

Free-market economists argue that intervention should be limited to only the most basic services, such as national defence.

Government intervention aims to achieve a more equitable distribution of income to reduce poverty.

A non-market-based policy is where the government directly intervenes in a market, for example by enforcing regulations or providing goods directly.

False.

A smoking ban is a non-market-based policy because the government directly intervenes through regulation.

Governments intervene through public expenditure, taxation, price controls, and legislation and regulation.

True.

The intervention a government chooses is shaped by its macroeconomic objectives.

Governments collect tax revenues to fund essential services, public goods and merit goods.

To improve the overall performance of the economy and raise living standards for the population as a whole.

An indirect tax is an expenditure tax that is paid when goods and services are purchased.

An indirect tax raises firms' costs of production, shifting the supply curve upward by the amount of the tax.

True.

A subsidy lowers firms' costs of production, shifting the supply curve to the right (downward).

An indirect tax shifts the supply curve upward by the amount of the tax.

A producer subsidy is a per-unit amount of money given to a firm by the government to encourage output.

The split depends on the price elasticity of demand (PED) and the price elasticity of supply (PES).

True.

Because demand is inelastic, the higher price causes only a small fall in quantity demanded, limiting the tax's effect.

Tax incidence is the share of an indirect tax that is paid by each party, the consumer and the producer.

Producers keep some of a subsidy and pass the rest on to consumers through lower prices.

The burden is greater for the consumer when demand is price-inelastic or supply is price-elastic.

A specific tax is a fixed amount of tax per unit of a good, which shifts the supply curve up by a constant amount.

True.

Subsidies aim to raise the output and consumption of goods such as merit goods.

A subsidy distorts the allocation of resources and carries an opportunity cost for the government.

A price control is government intervention that changes the existing market price to influence production or consumption.

It creates excess demand, a shortage, because quantity demanded exceeds quantity supplied.

True.

A higher price increases supply and reduces demand, creating an excess supply (surplus).

A maximum price is set below the free-market equilibrium price.

A price ceiling is a maximum price set by the government below the equilibrium price, above which sellers cannot legally sell.

To help consumers afford essential goods and services when the market price is too high.

A price floor set above equilibrium creates excess supply, also called a surplus.

A price floor is a minimum price set by the government above the equilibrium price, below which sellers cannot legally sell.

True.

A minimum price supports producer incomes and, for demerit goods, discourages consumption toward the socially optimal level.

A minimum price of 50 pence per unit of alcohol has been introduced in Scotland and Wales.

A minimum price is set above the free-market equilibrium price.

True.

The lower price reduces the incentive to supply, causing a contraction in quantity supplied.

They can create illegal markets and an inefficient allocation of resources because of the resulting shortage.

Competition policy is government policy that aims to make markets more competitive and to ensure that the public interest is protected.

The Competition and Markets Authority (CMA) oversees competition policy in the UK.

True.

The CMA monitors mergers with the aim of stopping any single firm from gaining more than 25% market share.

One way to control monopoly power is to prevent it forming, so the CMA monitors merger activity to stop harmful deals.

Compulsory break-up is a competition policy where a monopoly is forcibly split into smaller firms so that no single company controls the market.

Regulators set maximum prices to lower prices and raise output, ideally at the allocatively efficient level.

Profit regulation limits the supernormal profit a monopoly can earn by adding a set percentage of profit onto the firm's calculated total costs.

False.

Profit regulation removes the incentive to lower costs, so if costs stay high consumers still end up paying higher prices.

Removing government regulations lowers industry costs and barriers to entry, increasing a market's contestability.

Competitive tendering is where the government outsources the supply of goods and services to private firms, generating more private sector activity and competition.

Privatisation encourages new entrants because firms feel they can compete more effectively once the dominant firm is no longer government-owned.

True.

Intervention can create market distortions and inefficiencies, meaning competition policy may itself cause government failure.

Public ownership is government ownership of firms, industries or other assets, also known as state ownership.

Nationalised industries can take account of positive externalities, for example public transport reduces congestion and pollution.

Nationalisation is the transfer of assets from the private sector into public ownership.

False.

Publicly owned firms tend to be inefficient and lack dynamic efficiency because they lack competition, which can lead to market failure.

Public ownership can create a natural monopoly, such as water, where it is inefficient to have multiple sets of pipes.

Privatisation is the transfer of assets from the public sector (state) to the private sector.

The sale of state-owned assets raises short-term revenue for the government and reduces public spending.

True.

Privatised monopolies can restrict output to generate supernormal profits, which is a disadvantage of privatisation.

Increased competition gives profit-maximising firms an incentive to become more efficient and lower costs, which may lower prices.

British Airways was privatised in the UK and now operates in the competitive market.

The government may lack the expertise to run the business effectively.

True.

Government assets are often sold well below their actual market value, which is a disadvantage of privatisation.

Regulation is the process of monitoring and enforcing the laws.

Governments create rules to limit harm from negative externalities and to create competitive markets.

True.

The UK has more than 90 regulators monitoring that the rules are not broken.

Firms breaking the rules may be fined or imprisoned, which provides a disincentive to break the rules.

Ofgem regulates the energy market and Ofwat regulates the water market.

Regulation can act as a barrier to entry, discouraging smaller businesses and reducing competition.

Deregulation is the process of removing government controls from markets to increase competition and the efficiency of markets.

Other firms entered the postal market, increasing consumer choice and improving service.

True.

Deregulating important industries like airlines can raise safety concerns, which is a disadvantage of deregulation.

Deregulation may create a private firm with monopoly power as smaller companies are unable to compete.

Regulation can create unintended consequences and high enforcement and administration costs, leading to government failure.

False.

Consumers may pay higher prices if a deregulated market is left unregulated and a firm gains monopoly power.

State provision is where the government provides goods and services, such as merit goods and public goods, to correct market failure.

Private firms do not provide public goods because of the free rider problem, so they are under-provided.

True.

Products that are free may cause excess demand and long waiting times, such as lengthy waits for GP appointments.

Regulation can limit or prohibit demerit goods to reduce their consumption and limit external costs, for example banning certain classes of drugs.

True.

Collusion and cartels are banned and regulated by the CMA to prevent the abuse of monopoly power.

Common pool resources are natural resources over which no private ownership has been established.

Left to the free market, common pool resources can be over-exploited, resulting in the tragedy of the commons.

Property rights define the ownership of common pool resources and set out how they can be used.

Transferring common resources to private ownership gives owners an incentive to manage them, which internalises the externality.

Pollution permits are permits issued to polluting firms that allow each firm to pollute up to a set amount, with any surplus able to be sold and traded.

Firms switch to cleaner technology when the price of additional permits is more than the cost of investing in new pollution technology.

True.

Firms may relocate production to places with no pollution limits, which is a disadvantage of pollution permits.

Government failure occurs when government intervention to correct market failure results in a misallocation of resources and reduces overall economic welfare.

False.

Government failure occurs when intervention itself creates market distortions and reduces overall economic welfare.

Governments do not have perfect information and may not understand the market, so they are subject to information gaps and cognitive biases.

Regulatory capture occurs when firms influence regulators to change their decisions or policies to align more with the interests of the firm.

Price intervention can artificially alter the signalling function of prices, causing an inefficient allocation of resources, surpluses and shortages.

A minimum price can signal producers to supply more, and in agricultural markets this has often created an excess of perishable products.

Achieving one policy can come at the expense of another, forcing a trade-off, such as economic growth versus environmental protection.

True.

When administration costs are greater than the welfare saved, intervention worsens the allocation of resources.

Unintended consequences are unforeseen outcomes of intervention, such as the creation of illegal markets as people seek loopholes to maximise self-interest.

Firms spend millions lobbying regulators or politicians, which can lead to regulatory capture.

Reduced alcohol consumption may increase consumption of more harmful intoxicants as they become relatively cheaper.

True.

A maximum price signals producers to supply less, which in pharmaceutical markets has led to excess demand.