Economics Theme 1 Part 5 (First Half) Market Failure And Government Intervention

Front 1

When does Market Failure exists?

Back 1

When the market forces fail to achieve an economically efficient equilibrium

Front 2

List the 7 types of Market Failure

Back 2

Imperfect Information/Information Gaps

Missing Markets/Public Good

Externalities

“Irrational Behaviour”

Inequality

Factor Immobility

Market Power(e.g. monopoly)

Front 3

Define “Irrational Behaviour”

Back 3

Consumers do not always act in their best interests to maximise utility

Front 4

Define Missing Markets/Public Goods

Back 4

This is where the price mechanism fails to provide some goods and services e.g. street lighting

Front 5

Define externalities

Back 5

The effect on a third party not involved in the economic decision e.g. pollution

Front 6

Define Imperfect Information/Information Gaps

Back 6

There may not be enough information to make a rational decision

Front 7

Define Inequality in terms of market failure

Back 7

The unequal distribution of income created by the price mechanism

Front 8

Define Factor immobility

Back 8

It may be difficult to move factors of production from one type of product to another

Front 9

Define how Market Power (e.g. Monopolies) is a type of market failure

Back 9

If one firm has too much market power it can use this to exploit consumers and raise prices

Front 10

List 12 ways the government can intervene to deal with market failure

Back 10

Provision of information

Regulation

State provision (of public goods)

Tradable Permits

Maximum prices

Minimum Prices

Subsidies

Indirect Taxation

Nudge

Extension of Property Rights

Prohibition (e.g. drugs)

Restriction (e.g. alcohol)

Front 11

What is the current dominant economical ideology?

Back 11

Neoclassical economics

Front 12

What is assumed about economic agentes in neoclassical economics?

Back 12

It is assumed that economic agents make rational decisions as consumers to try to maximise utility and firms aim to maximise profits

Front 13

What shows that consumers often do not act rationally?

Back 13

Behavioural economics

Front 14

What does it mean for consumers to not act rationally?

Back 14

They will not respond appropriately to the signals and incentives given out by the price mechanism

Front 15

List 3 examples of non-rational behaviour

Back 15

Consideration of Other Peoples Behaviour

Habitual Behaviour

Consumer Weakness at computation

Front 16

Explain How “Consideration of Other People’s Behaviour” is an example of non-rational behaviour

Back 16

Humanas don’t like to feel left out. Often face “peer pressure to conform. “Herd-like mentality can occur in various markets e.g. smoking

Individuals may not like it, but participate in order to fit in

Front 17

Explain How “Habitual Behaviour” is an example of non-rational behaviour

Back 17

Consumers form habits. Aren’t willing to risk something new there is more uncertainty. E.g. changing banks or energy suppliers.

May not wish to deal with the “difficulties” of changing and hence are more likely to stick to the “status quo” even if changing is easy and the new product is objectively superior

Front 18

Explain How “Consumer Weakness at computation” is an example of non-rational behaviour

Back 18

Even if consumers wanted to make the most rational choice they may lack the mathematical ability to calculate best buys. Often have poor understanding of calculating probability. Consumers are also often unrealistic about their own future behaviour. e.g. signing up to year long gym memberships. Addictive substances also cause people to act irrational

Front 19

How may the government combat irrational consumer behaviour?

Back 19

Compulsion- forcing/trying to more subtly change consumer behaviour. E.g. Nudges

Front 20

Explain how the policy of “Nudges” works

Back 20

Nudges are a psychological tactic to encourage consumers to make a choice. It suggests that consumer behaviour can be influenced by small suggestions and positive reinforcements

Front 21

List 7 types of Nudges

Back 21

Status Quo Bins

Conforming

Feedback

Choice Architecture

Framing

Naming Conventions

Positioning

Front 22

Name 2 Advantages of Nudges

Back 22

Consumers are still left with choice

Uses human psychology to encourage people to make the “best choice”

Front 23

List 4 disadvantages of Nudges

Back 23

- may not work if desires are strong e.g. addiction to smoking

-may be seen as sneaky by consumers

-does not encourage people to think for themselves

-only works if it changes the culture

Front 24

What could be used instead of nudges to tackle irrational behaviour?

Back 24

Taxes, State Provision, Advertising, Subsiding a good, Regulation

Front 25

Define State Provision

Back 25

If the market under provides a good or service the government can do this directly

Front 26

Define Regulation

Back 26

The government will pass laws which can alter the price, quality or quantity of the product available

Front 27

What does economic theory assume in regards to knowledge?

Back 27

It assumes that economic agents have perfect knowledge, meaning they are able to accurately evaluate the costs and benefits of decisions

Front 28

List 3 incidences of imperfect information

Back 28

Asymmetric Information

Adverse Selection

Moral Hazard

Front 29

Define Asymmetric Information with an example to aid the explanation

Back 29

A situation where one economic agency has more information than another. This can lead to consumers being over charged or sold a good of inferior quality as they do not know how to assess the value of a product.

E.g. Doctors, Buying a house, Loans, Hiring Working, MOTs, University Admissions

Front 30

Define Adverse Selection with an example to aid the explanation

Back 30

This occurs when participation in the market is affected by asymmetric information. E.g. Health Insurers don’t know if you’re a smoker or non-smoker do will offer the average price. Non-smokers will feel that it is too expensive and leave the market pushing up the price as only high risk smokers remain

Front 31

Define a Moral Hazard with an example to aid the explanation

Back 31

This occurs when people are likely to behave more recklessly because they have insurance

E.g. Benefits, Banking Industry(always bailed out) Car Insurance, Eurozone Debt

Front 32

How can the government deal with the problem of imperfect information? (Give an example)

Back 32

State Provision of information to reduce the impact of asymmetric information by improving the level of information available to economic aged or providing organisations such as a watchdog to ensure neither consumers nor producers are being exploited

E.g. National Health Campaigns for smoking

Front 33

Explain how the policy of State Provision of information would work

Back 33

As information gaps cause market failure, governments can intervene by provision of information through social media, such as internet, television, radio, newspapers and text messages. Alternatively they can force companies to publish data.

Front 34

List 3 advantages of State Provision of Information

Back 34

-ensures producers and consumers are better informed

-should lead to lower consumption of harmful products

-,consumers will still retain choice

Front 35

List 4 disadvantages of State Provision of Information

Back 35

-Consumers may not understand/ignore the information

-Consumers may behave irrationally (habit/herding)

-Risk of Regulatory Capture(where government acts in industry interest)

-Opportunity Cost(money could be spent somewhere else)

Front 36

What are other substitutes to State Provision of Information to tackling imperfect information (asymmetric information, adverse selection, moral hazards)

Back 36

Regulation on Minimum Standards (asymmetric information)

Screening of Customers(health checks), (adverse selection)

High Excess(what a consumer pays) when claiming on Insurance Policies. (Moral hazard)

Front 37

What is a private good?

Back 37

A good that is excludable rivalrous and rejectable

Front 38

What does it mean for a good to be excludable? Give an example to develop your explanation

Back 38

An excludable good is one that people other than who the good was produced for cannot benefit from it. E.g. if you buy a car you can stop others from driving it

Front 39

What does it mean for a good to be rivalrous? Give an example to develop your explanation

Back 39

This means that the consumption of the good affects others’ ability to consumer the good. E.g. two people can’t wear a t-shirt at the same time

Front 40

What does it mean for a good to be rejectable? Give an example to develop your explanation

Back 40

You have the choice whether to consume it. E.g. it is not compulsory to buy a wireless stereo

Front 41

What are public goods and what differs between the two types?

Back 41

Goods that are non-excludable, non-rejectable and non-rivalrous. Goods that fulfil some of these criteria are called quasi-public goods but goods that fulfil all of the criteria are called pure public goods.

Front 42

List 7 examples of private goods

Back 42

Chocolate

Phone

Cans

Papers

Bananas

Surgery

T- Shirt

I.e. anything provided by the free market

Front 43

List 7 examples of pure public goods

Back 43

Street lighting

Flood protection

Lighthouse

Air

National Defence

Protection Provided by Vaccinations

Fire Brigade

Front 44

List 5 examples of Quasi Public Goods

Back 44

Swimming Pool

A road

Parks

TV Broadcasting

Wifi

Front 45

Will enough public goods be provided by the free-market?

Back 45

In a pure free-market, there will be under provision of public goods due to the existence of of free riders (someone who used it does not pay for a good or service)

As public goods are non-excludable it is difficult to charge people for benefiting from a good or service once it is provided.

If not enough people are willing to pay then there will be not enough money to provide sufficient quantities of the good and it will be under provided (a missing market)

Front 46

What will the government do because of the free rider problem?

Back 46

Government must pay for production with tax revenue as due to the free rider problem not enough public goods will be produced

Front 47

Why is it difficult for the government to work out the value of public good provision?

Back 47

Value of a product is normally calculated by what consumers would be willing to pay for it

However because of free riders it is difficult to work out how much people would be willing to pay

Therefore it is difficult to work out the total utility of the government providing a public good.