1.4 Market Failures

IBMichelle
Mind Map by IBMichelle, updated more than 1 year ago
IBMichelle
Created by IBMichelle almost 6 years ago
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Description

IB Economics (1: Microeconomics) Mind Map on 1.4 Market Failures, created by IBMichelle on 04/17/2014.

Resource summary

1.4 Market Failures
1 Externalities

Annotations:

  • Externality leads to a market failure as either more or less than the socially optimal amount is produced or consumed (therefore inefficient resource allocation)
1.1 Components
1.1.1 MSC
1.1.2 MSB
1.1.3 MPB
1.1.4 MPS
1.2 Types
1.2.1 Positive Externality of Consumption

Annotations:

  • If there is an external benefit then the MSB curve lies below the D,MPB curve
  • Example: - Flu Shots (less people infected)
1.2.1.1 Underconsumption of certain products
1.2.1.1.1 Merit Goods

Annotations:

  • Consumption of these goods creates a very positive externality (e.g. education and health care)
  • Alternative Definition: Goods that government would like all members of society to consume in adequate quantities independently of their income or even their preferences (e.g. compulsory education)
1.2.1.2 Solution
1.2.1.2.1 Granting a Subsidy

Annotations:

  • Type of MARKET-BASED SOLUTION
1.2.1.2.2 Legislation and Direct Provision

Annotations:

  • Type of COMMAND-AND-CONTROL SOLUTION e.g. Free Education
1.2.1.2.3 Advertisements/ Moral Pursuation
1.2.2 Positive Externality of Production

Annotations:

  • If there is an external benefit from the MSC curve lies below the S,MPC curve
  • Example: - Beekeepers producing honey next to apple orchards (as bees will pollinate flowers)
1.2.2.1 Underproduction of Good
1.2.2.2 Solution
1.2.2.2.1 Granting a Subsidy

Annotations:

  • Type of MARKET-BASED solution 
1.2.2.2.2 Assigning Intellectual Property Rights

Annotations:

  • Type of MARKET-BASED solution 
1.2.2.2.3 Mergers

Annotations:

  • Type of MARKET-BASED solution 
1.2.2.2.4 Direct Regulation

Annotations:

  • Type of COMMAND-AND-CONTROL SOLUTION
1.2.3 Negative Externality of Consumption

Annotations:

  • If there is an external cost then the MSB curve lies below the D, MPB curve
  • Example: Consumption of alcoholic beverages (leading to violence, drunk driving, etc.)
1.2.3.1 Overconsumption of certain products
1.2.3.1.1 Demerit Goods

Annotations:

  • The consumption of a good creates very significant negative externalities (e.g. Alcoholic drinks and Tobacco)
  • Alternative Definition: Goods of which governments would like to limit consumption
1.2.3.2 Solutions
1.2.3.2.1 Imposing Indirect Taxes

Annotations:

  • Type of MARKET-BASED solution
1.2.3.2.2 Direct Regulation

Annotations:

  • Type of Command-and-Control Solution
1.2.3.2.3 Advertisements

Annotations:

  • Type of Command-and-Control Solution
1.2.4 Negative Externality of Production

Annotations:

  • If there is an external cost then the MSC curve lies above the S, MPC curve
  • Example: Cement INdustry polluting the atmosphere
1.2.4.1 Overproduction of the good/ service
1.2.4.2 Solutions
1.2.4.2.1 Market-Based Solutions
1.2.4.2.1.1 Indirect Taxation

Annotations:

  • - raises the production costs (therefore forcing the supply curve to shift to the left)
1.2.4.2.1.2 Property Rights over Assets
1.2.4.2.1.3 Tradable Pollution Permits

Annotations:

  • e.g. cap and trade schemes
1.2.4.2.2 Command and Control Solutions
1.2.4.2.2.1 Direct Government Regulations
1.2.4.2.2.2 Advertisements
1.2.4.2.2.2.1 Persuading the public through education
2 Public Goods

Annotations:

  • Pure Public Goods example: Lighthouse, Traffic Lights, Law and Order (debatable), Broadcast Television and Radio (debatable) 
2.1 Characteristics
2.1.1 Non-Excludable
2.1.1.1 Existence of Free-Riders

Annotations:

  • Individuals hiding their true preferences due to the fact that they can enjoy the good without having to pay for it once it becomes available for others
2.1.2 Non-Rival
2.1.2.1 No marginal cost of an extra user
2.2 Externality
2.2.1 Positive Externality of Consumption
2.2.1.1 MSB > MPB
2.2.1.2 BUT: MPC > MPB
2.2.1.2.1 Good may not be supplied
2.2.1.2.1.1 Lack of incentives
3 Common-access resources
3.1 Tragedy of the Common
3.1.1 Causes Negative Externality of Production
3.1.2 Solutions
3.1.2.1 Extending Property Rights
3.1.2.2 Appropriate Institutional Framework
3.1.2.3 Direct Regulation
3.1.2.4 Education
4 Monopoly Power
4.1 Solutions
4.1.1 Governments ensure competitive conditions
4.1.1.1 Liberalizing Free Trade
4.1.1.2 NO mergers / acquisitions
4.1.1.3 Monitoring anti-competitive practices
4.2 Abnormal Profits
5 Asymmetric Information
5.1 Problems
5.1.1 Adverse Selection

Annotations:

  • Producers may not be able to test the true quality of its product
5.1.2 Misalignment of incentives
5.1.3 Moral Hazard Problem arises
5.2 Solutions for Firms
5.2.1 Signalling

Annotations:

  • One of the parties tries to convey information about itself that will make it seem credible (e,g, issuing warranties, etc.)
5.2.2 Screening

Annotations:

  • Individuals try to infer additional information from other observable characteristics
5.2.3 Building good reputations
5.2.4 Contracts Creations
5.3 Solutions for Governments
5.3.1 Providing more information
5.3.2 Legislations
5.3.2.1 Standards
5.3.3 Regulating Firm's Behavior
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