AS Microeconomic Revision B
DW Wellings May 20121
Market failure
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Main points
Market failure occurs when resources are not being used in a way that the best allocation
for consumers.
In simple terms market failure occurs when supply does not equal demand. Allocative
efficiency occurs when supply equals demand.
Productive efficiency is where the economy is on the PPF. If you want to increase the use of
one resource you have to reduce your use of another. In short, you cannot increase the use
of resources in one area without cutting back on another.
Economic efficiency occurs when both allocative and productive efficiency are present.
Economic efficient market can only occur where buyers and sellers having accurate and upto date information about the market.
Key terms
Market failure – where the free market fails to achieve economic efficiency.
Allocative efficiency – where demand equals supply and there are no surpluses or shortages.
Productive efficiency – where production takes place using the least amount of scarce resources.
Economic efficiency – where both allocative and productive efficiency are achieved.
Free market mechanism – the system where demand and supply determine prices and the decisions
made by consumers and forms.
Information failure – a lack of information resulting in consumers and producers making decisions
that do not maximise welfare.
Key theoretical concepts
Allocative efficiency
Costs, benefits and externalities
Main points
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Economists differentiate between private costs and private benefits. Private costs are the
costs incurred by private firms through economic activity. Private benefits are the positive
results of business activity, such as profit.
Economists differentiate between public costs and public benefits. Public costs are the
negative effects of economic activity on the rest of society, such as pollution. Public benefits
are the positive results of business activity on wider society, such as a local multiplier effect.
Negative externalities occur where marginal social costs are greater than private costs.
Positive externalities occur where marginal social befit of economic activity exceeds the
private benefit.
Negative externalities include illegal dumping of waste, and binge drinking. Positive
externalities include inoculations, education and training and infrastructure projects.
Key terms
Private costs and benefits – the costs and benefits incurred by private firms as a result of economic
activity.
Public costs and benefits – the costs and benefits to third parties as a result of economic activity.
Negative externality – this exists where the social cost of an activity is greater than the private cost.
Positive externality – this exists where the social benefit of an activity exceeds the private benefit.
Key theoretical concepts
Positive and negative externalities
Public goods, merit goods and government intervention to correct market
failure
Main points
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Public goods are goods that are consumed collectively. They have the characteristics of nonexcludability and non-rivalry. Street lights and public parks are good examples of public
goods.
Quasi-public goods have some of the characteristics of a public good but not all. For
example toll roads and bridges are quasi public goods.
Merit goods are goods usually provided the government as they will be under- provided in a
free market. Examples include heath care and education. Demerit goods are goods that
would be overprovided by the free market but are banned by legislation. These include
guns, porn and drugs.
Governments can intervene by charge firms for negative externalities, providing merit
goods, subsidies, tradable permits, indirect taxation and the provision of information.
Key terms
Public goods – goods that are collectively consumed and have the characteristics of nonexcludability and non-rivalry.
Non-excludability – where individual consumers cannot be excluded from consumption.
Non-rivalry – where consumption by one person does not affect the consumption of others.
Free rider – someone who directly benefits from the consumption of a public good but who does not
contribute to its provision.
Subsidy – payment from government to encourage production or consumption.
Tradable permits – a permit that allows a producer to emit a certain amount of pollution and can be
traded with other polluters.
Key theoretical concepts
The effects of imposing an indirect tax.
The effects of introducing a subsidy
Price determination of tradable pollution permits.
The effects of imposing an indirect tax.
The effects of introducing a subsidy
Price determination of tradable pollution permits.