Sunday 22 November 2009

Market failure and government intervantion

Market failure:where the free market mechanism fails to achieve economic efficiency.
It mens that resources are not being used in a way that produces the best allocation for consumers.
Efficiency: where the best use of resources made for the benefit of consumer.
There are two types of efficiency that recognised in
economics:

Allocative efficiency: where consumers satisfaction is maximised.
Scarce resources are used to produce those goods and services that consumers actually demand.To ahieve this the quantity supplied mast be equal to the quantity that is demanded-equilibrium position.
Productive efficiency: where production takes place using the least amount of scarce resources.It can be explained in terms of production possibility curve (PPC).
When scarce resources have been used in the most efficient way it is
economic efficiency.
Economic efficiency:
when both allocative and productive efficiency are acheived.
Therefore,
inefficiency-is market in which resources are not being used in the best possible way.So,
Inefficiency: any situation when economic efficiency is not achieved.
Free market mechanism: the system by which the marcet forces of demand and supply determine prices and the decisions made by consumers and firms.

Information failure.

The definition of economic efficiency made clear that the free market is producing the best allocation of resources when consumers are maximising their walfare.But in practice the ability of consumers to benefits in these terms is depended upon them having accurate, up-to- date information about the product that they want to consume.It is lack of this information that underpins most instances of market failure.
Information failure: a lack of information resulting in consumers and producers making decisions that do not maximise welfare.
In some situations
,the problem of information failure is known as asymmetric information.

Asymmetric i
nformation: information is not equally shared between two parties.

Externalities.
Externality: an effect whereby those not directly involved in taking a decision are effected by the action of others.
Third party: those not
directly involved in making a decision.

Costs and benefits.

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 cos
ts that are the concequence of externalities to the third parties.
External benefits:
the benefits that accrue as a concequence of externalities to third parties.
Social costs: the total costs of the particular action.
Social benefits:
the total benefits of the particular action.

Negative externalities.

Negative externality: when the social cost of an activity is greater than the private cost.

Negative externality in consumption.
Negative externality in production.


















Positive exte
rnality: this exist when the social benefit of an activity exceeds the private benefit.

Positive externality in consumption.