Edexcel A Level Economics A:复习笔记1.3.1 Types of Market Failure

Understanding Market Failure

  • In a free market, the price mechanism determines the most efficient allocation of scarce resources in response to the competing wants and needs in the marketplace
    • Scarce resources are the factors of production (land, labour, capital, enterprise)
    • Free markets often work very well
  • However, the free market sometimes leads to Market Failure, where there is a less than optimum allocation of resources from the point of view of society. For example, when the free market causes a lack of equity (inequality) or environmental degradation
    • There is either over-provision or under-provision of the goods/services and therefore an over-allocation or under-allocation of the resources (factors of production) used to make these goods/services
    • From society’s point of view there is a lack of allocative efficiency

Types of Market Failure

  • Sources of market failure include the existence of externalities, an under-provision of public goods, and the existence of information gaps in markets

Externalities

  • Externalities occur when there is an external impact (cost or benefit) on a third party not involved in the economic transaction
    • These impacts can be positive or negative
    • A positive externality of consumption occurs when the external impact on society/third party is positive such as when electric vehicles are consumed CO2 emissions fall
    • A positive externality of production occurs when the external impact on society/third party is positive such as when managed pine forests produce timber but also increase CO2 absorption
    • A negative externality of consumption occurs when the external impact on society/third party is negative such as when the consumption of alcohol increases anti social behaviour
    • A negative externality of production occurs when the external impact on society/third party is negative such as when the production of electricity increases air pollution
    • If these externalities were acknowledged, then the price and output in the market would be different
    • The price mechanism in a free market ignores these externalities

Public Goods

  • Public goods are beneficial to society but would be under-provided by a free market as there is less opportunity for sellers to make economic profits from providing these goods/services
    • Good examples include national defence, parks, libraries and lighthouses
    • They are therefore provided by the government for the public benefit

Information Gaps

  • Information gaps exist in nearly all free markets and distort market outcomes resulting in market failure
    • One of the underlying assumptions of a free market is that there is perfect information in the market
    • The reality is that in many markets buyers and sellers have different levels of information. This is called asymmetric information and distorts market prices and quantities
    • For example, goods/services with dangerous side effects would be sold in lower quantities if buyers were aware of these effects. Similarly, goods/services with extra benefits would be sold in higher quantities if buyers were aware of them

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