Market failure

  • Created by: Jess
  • Created on: 10-04-14 10:51

Market failure: where the free market mechanism fails to achieve economic efficiency

Economic efficiency: where both allocative and productive efficiency are achieved

Productive efficiency: where production takes place using the least amount of scarce resources

Allocative efficiency: where consumer satifisfaction is maximised 

Free market mechanism: the system by which the market forces of demand and supply determine prices and the decisions made by consumers and firms

Information failure: a lack of information resulting in consumers and producers making decisions that do not maximise welfare 


Asymmetric information: information not equally shared between 2 parties e.g. when purchasing insurance as a purchaser you know more about your circumstances than the seller, so the seller relies upon your honesty in deciding whether to sell you a policy

Externality: an effect whereby third parties are effected by the actions of others 

Third party: those not directly involved in making a decision

Private costs and benefits are experienced by the people who are directly involved in the decision to take a particular action

External costs and benefits are a consequence of externalities that arise from a particular action that fall on third parties.

Private costs: the costs incurred by those taking a particular action

Private benefits: the benefits directly accruing to those taking a particular action

External costs: the costs that are the consequence of externalities to third parties 

External benefits: the benefits that accrue as a consequence of externalities to third parties

Social costs: the total costs of a particular action

Social benefits: the total benefits of a particular action

Negative externalities: this exists where the social cost of an activity is greater than the private cost e.g. illegal dumping of watse - private cost in minimal…


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