2281 · 2.10
Market failure flashcards
Revision flashcards for Cambridge 2281 Market failure (syllabus 2.10). Flip, recall, then mark a real past-paper question.
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What is market failure?
When free markets fail to allocate resources efficiently — output differs from the social optimum.
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Negative externality effect on output?
MSC > MPC → market overproduces — too much output compared to social optimum.
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Positive externality effect on output?
MSB > MPB → market underproduces — too little output compared to social optimum.
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Why are public goods not supplied by markets?
Non-excludability causes free-rider problem — no profit incentive for private firms.
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What is information failure?
Consumers or producers lack full information — e.g. asymmetric information in healthcare or insurance.
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Where is the social optimum on an externality diagram?
Where MSC = MSB (or MSB = MSC for negative production externality at Q where marginal social cost equals marginal social benefit).
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What is the 'free-rider problem'?
A market failure that occurs when individuals can consume a good or service without paying for it. This is common with non-excludable goods (public goods) and removes the profit incentive for private provision.
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Define a merit good.
A good that is considered socially desirable but is under-consumed by the free market. This is often due to information failure, where individuals do not fully appreciate the long-term private benefits.
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What is meant by 'internalising an externality'?
An economic policy that aims to make the producer or consumer pay for the external costs they generate. For a negative externality, this could be a tax that increases the private cost to the level of the social cost.
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What is asymmetric information?
A type of information failure where one party in an economic transaction has more or better information than the other party, leading to a potential misallocation of resources.
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What are the two characteristics of a public good?
Non-rivalry (consumption by one person does not reduce availability for others) and non-excludability (it is not possible to prevent non-payers from benefiting).
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What is a demerit good?
A good that is considered socially undesirable and is over-consumed by the free market, often due to information failure about its long-term harms (e.g., cigarettes).