๐ Quick Study Guide: Understanding Market Failures
- ๐ง What is a Market Failure? It occurs when the free market fails to allocate resources efficiently, leading to a suboptimal outcome for society.
- ๐จ Negative Externalities: Costs imposed on a third party not involved in the production or consumption of a good. Examples: pollution from factories, loud music from neighbors. Government solutions: taxes, regulations.
- ๐ฑ Positive Externalities: Benefits conferred on a third party not involved in the production or consumption of a good. Examples: vaccinations, education, beautiful gardens. Government solutions: subsidies, public provision.
- ๐ก Public Goods: Goods that are both non-rivalrous (one person's consumption doesn't diminish another's) and non-excludable (difficult to prevent non-payers from consuming). Examples: national defense, streetlights. This leads to the free-rider problem.
- โ๏ธ Asymmetric Information: Occurs when one party in a transaction has more or better information than the other. This can lead to adverse selection (e.g., sicker people buying insurance) or moral hazard (e.g., insured people taking more risks). Examples: used car sales, health insurance.
- ๐ Market Power: When a single firm or a small group of firms has significant control over the price and output in a market, leading to higher prices and lower quantities than in a competitive market. Examples: monopolies, cartels.
- ๐ ๏ธ Government Intervention: Governments often intervene to correct market failures through policies like taxes, subsidies, regulations, direct provision of goods/services, and anti-trust laws.
๐ง Practice Quiz: Test Your Knowledge
1. What is the primary characteristic of a market failure?
A) Resources are allocated efficiently.
B) The market achieves an optimal outcome for society.
C) The free market fails to allocate resources efficiently.
D) All transactions benefit both buyers and sellers equally.
2. Which of the following is an example of a negative externality?
A) A beekeeper's bees pollinating a nearby apple orchard.
B) A factory polluting a river used by local fishermen.
C) A student getting a good education and becoming a productive citizen.
D) A public park available for everyone to enjoy.
3. Street lighting is often considered a public good because it is:
A) Excludable and rivalrous.
B) Excludable but non-rivalrous.
C) Non-excludable and non-rivalrous.
D) Rivalrous but non-excludable.
4. The "free-rider problem" is most commonly associated with which type of market failure?
A) Negative externalities.
B) Positive externalities.
C) Public goods.
D) Asymmetric information.
5. When a seller knows more about the quality of a product than the buyer, this is an example of:
A) Market power.
B) A positive externality.
C) Asymmetric information.
D) A public good.
6. Which of these government interventions is typically used to address negative externalities like pollution?
A) Subsidies to polluters.
B) Direct provision of the polluting good.
C) Taxes or regulations on polluting activities.
D) Providing more information to consumers about the benefits of pollution.
7. A single company having exclusive control over the supply of a vital medicine, leading to very high prices, is an example of:
A) A positive externality.
B) Asymmetric information.
C) A public good.
D) Market power (monopoly).
Click to see Answers
1. C
2. B
3. C
4. C
5. C
6. C
7. D