Exam code: 0455 & 0987
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Define externality.
An externality is an external impact on a third party not involved in the economic transaction between the buyer and seller.
Social cost = private cost + .
Social cost = private cost + external cost.
What is meant by private cost in economics?
A private cost is what the producer, consumer or government actually pays to produce or consume a good or service.
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Define externality.
An externality is an external impact on a third party not involved in the economic transaction between the buyer and seller.
Social cost = private cost + .
Social cost = private cost + external cost.
What is meant by private cost in economics?
A private cost is what the producer, consumer or government actually pays to produce or consume a good or service.
What is an external benefit?
An external benefit is a benefit not factored into the market transaction, experienced by a third party not involved in the original economic activity.
A bee farmer gains the of income from selling honey, while a nearby orchard gains the of pollination.
A bee farmer gains the private benefit of income from selling honey, while a nearby orchard gains the external benefit of pollination.
Define market failure.
Market failure occurs when the free market fails to allocate resources efficiently, resulting in a loss of social welfare.
There may be an of demerit goods (like cigarettes) or an of merit goods (like schools) in a market failure.
There may be an over-provision of demerit goods (like cigarettes) or an under-provision of merit goods (like schools) in a market failure.
True or False?
Market failure always means that nothing useful is produced by the market.
False.
Market failure means resources are not allocated efficiently from society’s point of view, not that nothing useful is produced.
What is meant by social welfare in economics?
Social welfare refers to the overall well-being and prosperity of society, often considered when evaluating market outcomes.
When external costs are not included in the market price, it can result in the of goods with negative externalities, such as pollution.
When external costs are not included in the market price, it can result in the overconsumption of goods with negative externalities, such as pollution.
Define market failure.
Market failure is when the free market results in a less than optimum allocation of resources from society's point of view.
What are the two characteristics of public goods?
Public goods are both non-excludable and non-rivalrous.
Demerit goods are because individuals how harmful they are to themselves.
Demerit goods are over-consumed because individuals underestimate how harmful they are to themselves.
What is the main reason for under-consumption of merit goods?
Merit goods are under-consumed because individuals undervalue their benefits due to lack of information or short-term thinking.
Define externality.
An externality is a cost or benefit that affects third parties not involved in an economic transaction.
True or False?
All merit goods also create external benefits.
False.
Not all merit goods have external benefits, though many do. The two concepts are related but not identical.
What distinguishes external costs from demerit goods?
External costs are harms to third parties, while demerit goods focus on harms underestimated by the consumer.
Overproduction of goods with and underproduction of goods with both lead to market failure.
Overproduction of goods with external costs and underproduction of goods with external benefits both lead to market failure.
Define demerit good.
A demerit good is a good that is over-consumed because individuals underestimate how harmful it is to themselves.
True or False?
Abuse of monopoly power can lead to market failure.
True.
Abuse of monopoly power can reduce competition, raise prices, and limit the supply or quality of goods and services, all of which are forms of market failure.
A key issue with is under-consumption due to misjudged private benefits.
A key issue with merit goods is under-consumption due to misjudged private benefits.
Define minimum price.
A minimum price is a price set by the government above the free market equilibrium and below which sellers cannot legally sell the good or service.
What is the effect of a minimum price imposed above equilibrium on supply and demand?
A minimum price above equilibrium increases the incentive to supply, causing supply to rise, and decreases the incentive to consume, causing demand to fall, resulting in excess supply.
A minimum price is often used by governments to help or to decrease consumption of a .
A minimum price is often used by governments to help producers or to decrease consumption of a demerit good.
What is excess supply in the context of minimum prices?
Excess supply occurs when the quantity supplied at the minimum price is greater than the quantity demanded, resulting in unsold goods in the market.
Define maximum price.
A maximum price is a government-set price below the free market equilibrium price above which sellers cannot legally sell the good or service.
Maximum prices are usually intended to help , especially during periods of .
Maximum prices are usually intended to help consumers, especially during periods of disruption.
What is the main disadvantage of maximum prices in markets?
The main disadvantage of maximum prices is that they create shortages, leading to excess demand, and may encourage the formation of illegal markets.
When a maximum price is set below equilibrium, the incentive to decreases and the incentive to increases.
When a maximum price is set below equilibrium, the incentive to supply decreases and the incentive to consume increases.
Define market failure.
Market failure occurs when the free market fails to allocate resources efficiently or fails to achieve social welfare.
Name four common government interventions to address market failure.
Four common interventions are maximum prices, minimum prices, indirect taxation, and subsidies.
Define national minimum wage (NMW).
A national minimum wage (NMW) is a legally imposed wage level set above the market equilibrium wage that employers must pay their workers.
True or False?
A national minimum wage can increase unemployment if set above the equilibrium wage.
True.
If the minimum wage is set above equilibrium, the supply of labour increases and the demand decreases, leading to excess supply of labour and potential unemployment.
Define indirect tax.
An indirect tax is a tax paid on the consumption of goods or services, usually levied by the government on producers and passed on to consumers when a purchase is made.
Indirect taxes are usually levied by the government on goods to reduce quantity demanded and/or to raise government revenue.
Indirect taxes are usually levied by the government on demerit goods to reduce quantity demanded and/or to raise government revenue.
Who pays an indirect tax: producers, consumers, or both?
Both producers and consumers pay a share of an indirect tax, known as the incidence of tax.
What is the main purpose of imposing an indirect tax on demerit goods?
The main purpose is to reduce the quantity demanded of demerit goods and/or to raise government revenue.
True or False?
The entire burden of an indirect tax is always paid by consumers.
False.
Both producers and consumers pay a share of the tax, depending on the price elasticity of demand.
How does the price elasticity of demand affect the incidence of an indirect tax?
If demand is price inelastic, consumers pay a greater share of the tax. If demand is price elastic, producers bear more of the tax burden.
What is a producer subsidy?
A producer subsidy is a per unit amount of money given by the government to firms to increase production or the provision of merit goods.
Which two groups share the benefit of a subsidy?
Both producers and consumers share the benefit of a subsidy, depending on the price elasticity of demand.
A subsidy shifts the supply curve to the .
A subsidy shifts the supply curve to the right.
True or False?
Subsidies can help change destructive consumer behaviour over the long term.
True.
Subsidies can make merit goods more affordable, encouraging consumers to adopt better behaviours over time.
What is a disadvantage of using subsidies to correct market failure?
A disadvantage is the opportunity cost of government spending, as the money could be used elsewhere, and subsidies can distort market resource allocation.
Define privatisation.
Privatisation is when the government transfers ownership and control of firms or assets from the public sector to the private sector.
What is one possible advantage of privatisation for the government?
One advantage is that privatisation can increase government revenue in the year the asset is sold.
What is a potential disadvantage of privatisation for consumers?
A potential disadvantage is that private firms may increase prices as they seek to maximise profit.
Nationalisation occurs when the government and firms that were in the private sector.
Nationalisation occurs when the government takes control and ownership of firms that were in the private sector.
What is an advantage of nationalisation for society?
Nationalisation can create more equity in society, as all citizens have the same access to resources at the same price.
True or False?
Nationalisation always leads to efficient management of government firms.
False.
Government firms can often run inefficiently, and the government may lack the expertise to run the business.
Define quota.
A quota is a government-imposed limit on the quantity of a good or service that can be produced, consumed, or imported over a specific period.
How can quotas help protect the environment?
Quotas can protect scarce natural resources by limiting extraction or production, reducing overexploitation and supporting sustainability.
Strict quotas may encourage markets or unregulated over-extraction.
Strict quotas may encourage black markets or unregulated over-extraction.
What was the main goal of New Zealand's Quota Management System (QMS) in fisheries?
The QMS aimed to prevent overfishing and ensure the sustainability of fish stocks.
Define direct provision.
Direct provision is when the government supplies goods or services that are beneficial for society and are not provided adequately by the private sector, such as public goods and merit goods.
What is a key advantage of government regulation in markets?
Regulation helps to reduce the external costs of demerit goods by limiting harmful activities.
Public goods are often provided by the government because of the problem.
Public goods are often provided by the government because of the free rider problem.