1.3 Market Failure (Edexcel A Level Economics A)

Information gaps distort market outcomes, resulting in market failure.

Asymmetric information is when buyers and sellers have different levels of information about a good or service.

An externality is a third party spill-over effect on individuals not involved in the economic transaction.

External costs are calculated using the formula

Social costs are calculated using the formula

A private cost is what producers pay to produce a good or service and what consumers pay to purchase a good or service.

Social benefits are

Marginal private cost is the cost of producing the next additional unit of a good or service.

Marginal social benefit is assumed to be equal to marginal private benefit when focusing on the producer side of the market.

Over-provision means the free market produces more of a good or service than is socially optimal due to negative externalities.

False.

Under-consumption results from positive externalities of consumption.

The welfare loss triangle represents the loss to society due to over-provision or under-provision of goods and services.

Government intervention can address externalities through measures such as taxes, subsidies, legislation and regulation.

A merit good is a good that has positive externalities in consumption and is under-consumed in a free market.

A private good is a good that a firm produces to generate profits and consumers consume to gain utility, as it is excludable and rivalrous.

Non-excludability is the inability to prevent non-paying consumers from accessing a good or service.

Non-rivalry means that one person's consumption of a good does not reduce its availability to others.

Private firms do not provide public goods because they cannot generate profits due to non-excludability and non-rivalry.

The free rider problem is a situation where people can benefit from a good or service without paying for it.

The free rider problem leads to under-provision or no provision of public goods in a free market.

False.

Public goods are often, but not always, provided by the government.

Examples of public goods include

• street lighting

• flood defences

• public parks

Public goods differ from merit goods in that private firms will not provide public goods at all, while some merit goods are provided by private firms, but underconsumed.

The main characteristic of public goods is that they are both non-excludable and non-rivalrous.

National defence is considered a public good because it is non-excludable and non-rivalrous.

The government typically funds public goods through taxation.

An information gap is a difference in the level of information available to buyers and sellers in a market.

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

Asymmetric information is when buyers and sellers have different levels of information about a good or service.

Information gaps distort socially optimal prices and quantities in markets, resulting in over-provision or under-provision of goods and services.

False.

Perfect information is an underlying assumption of free markets but rarely exists in reality.

An example of a market with asymmetric information is the used car market, where sellers know more about the vehicle than buyers.

Asymmetric information can lead to market failure by causing inefficient allocation of resources and sub-optimal market outcomes.

Adverse selection is a market outcome where buyers or sellers use private information to their advantage, leading to inefficient outcomes.

Moral hazard is a situation where one party takes more risks because another party bears the cost of those risks.

Information gaps can lead to a decrease in the overall quality of goods in a market as sellers may have an incentive to offer lower quality products.

A government can address information gaps by implementing regulations, requiring disclosures or providing information directly to consumers.

Information gaps might lead to mispricing of goods, as buyers may not have accurate information about the true value or quality of a product.