Notesale: Turn your study into money

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Compiled by Hope C/verityvirtue

MARKET FAILURE COMPILATION
Question hint-words
efficiency in resource allocation // government intervention + externalities, public goods…

Introduction
● Define MF: the failure of the free market system to achieve ​
efficient allocation of resources​
or
other social goals like equity
...
Allocative efficiency is achieved when society produces the combination
of goods and services that maximises society’s welfare
...
However, consumers tend to underestimate the potential positive impacts of xxx on their
personal well-being due to imperfect information and because consumers ignore the
significant positive externalities in consumption arising from xxx in the pursuit of self-interest
...
Market failure results as there is allocative inefficiency under an
unregulated free market system
...

○ Induce private decision makers to consider external benefits by internalising positive
externalities ⇒ increases equilibrium output from ___ to the socially optimum ____
where ​SC = MSB​
M

...

diagram! →

Compiled by Hope C/verityvirtue

● Evaluation​
: difficult to estimate external benefit as may be intangible, govt may not have
perfect information
● Education
● To reduce market failure arising from imperfect information, the government can
provide information about the personal benefits of xxx
...
Providing
more information prevents a welfare cost (area) that arises from imperfect information
...

According to (Figure), free market equilibrium will be at 0Q0
...
Hence, under imperfect information, too little resources will be diverted to the consumption
and production of xxx
...

Measures
Education:

DEMERIT GOODS
NEGATIVE EXTERNALITIES
If left to the free market, consumption of xx will be higher than the socially desired level of usage
...
For instance… (insert specific example →
must be about third party effects)
According to (figure), free market equilibrium will be at ___ where MPB of consumption of xxx equals
MPC of xxx, but the allocatively efficient xxx consumption level is ___ where MSB of xxx consumption
= MSC of xxx consumption
...

diagram →

Compiled by Hope C/verityvirtue

Measures
● QUOTA
○ According to (figure), free market equilibrium is at OQ​However, there is still an
e
...
The quota can limit the
maximum number/amount of xxx traded to (refer to diagram) → how it will lessen
negative/positive externalities

IMPERFECT INFORMATION
How it causes MF
Individuals may not be fully aware of the negative consequences of xxx
...
If left to free market forces,
consumers’ demand under imperfect information is higher than the demand under perfect information
...

However, the socially optimal level of consumption and production is at output OQs
...
A welfare
cost represented by area ___ arises from imperfect information as the benefits gained in consuming
QsQp units of xxx are less than the resources used in producing QsQp units of xxx
...
​
N
means that ​arginal cost of providing
m
one extra unit of the good is zero​ to remain allocatively efficient, producers are unable to charge a
, so
price for the good
...

Non-excludability​
means that producers cannot exclude anyone from using the good once it is
produced, reuslting in the​ rider problem
free
​
Measures
● Direct provision:​ cost-benefit determines that the likelihood of benefits from the good is
if
more than or equal to the cost of producing it, then
○ Evaluation:​
difficult to put a value to benefit from a good, may have private sponsors
hence no need for government provision,
○ assuming merit goods are provided free of charge, government provider cannot rely on
price signals to estimate level of consumer demand
...

diagram!

Compiled by Hope C/verityvirtue

Consider possibility of a natural monopoly, especially with small market demand and high capital
outlay
LRAC of the firm falls continuously across a large output range due to extensive IEOS that results from
spreading out of high setup costs
Measures
● Legislation - anti-competition laws
● AR and MR of firm shifts left and becomes ​ore price elastic
m
● At profit max position where MR = MC, lower price is charged → quantity demanded
increases
● smaller divergence between P and MC, hence reduces the degree of allocative
inefficiency and exploitative pricing by dominant firms
...

● Compare PED and PES of labour for low-skilled and high-skilled workers
diagram! →

Compiled by Hope C/verityvirtue

Measures
● Minimum wage
○ minimum wage set above existing wage level → minimum standard of living
○ Extent of unemployment depends on PED/PES of low-skilled workers
■ DD usually price elastic b/c jobs can be replaced with automation
■ SS elastic if have ready pool of labour



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