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Definitions Unit 4b
4.3.1b: Do Markets Always Work?
What Market Failure Means
Market Failure Situations where free market forces have led to an inefficient allocation of resources.
Merit Goods Socially desirable under produced if left to the free market customers will be unwilling
to pay private costs e.g. healthcare, education.
Public Goods Cannot be efficiently produced by the private sector available to all freerider
problem businesses cannot charge for them.
Equity Fair distribution of income and wealth, `fair' dependent on political opinion.
What Are Externalities?
Private Benefits Received by the firm or individual when goods and services are purchased.
Private Costs Those paid by individuals and firms when buying goods and services.
External Benefits Reflect the positive side effects from firms or individuals using goods and services
that they have paid for.
External Costs Reflect the side effects of a firm or individual using a product negative effects on a
third party, not producer or consumers.
Social Benefit Total benefit arising from producing goods and services (private benefits + external
Social Costs Total costs of producing goods and services (private costs + external costs).
Externalities All costs and benefits that affect third parties, aka spill over effects.
If social costs exceed private costs there is a negative externality.
If social benefit exceeds private benefit there is a positive externality.
To What Extent Are Externalities Acceptable?
Marginal Social Benefit (MSB) The amount that society as a whole gains from the consumption of
one more item.
Marginal Social Cost (MSC) The cost to society as a whole of the consumption of one more item.
Costbenefit Analysis investigating all private and external costs and benefits of a possible project.
Externalities And Government Policy
Environmental Charges Government imposed fees for using natural resources e.g. charges in the
UK on the disposal of waste.
Green Taxes Are taxes on output. Intention of the tax is to charge for negative effects of production
and consumption on the environment. In order to be socially efficient the green tax should be equal to
the external costs of production.
4.3.2b: Should Markets Be Regulated?
Why Regulation Is Needed
Mergers and Acquisitions Occur when one company takes over another or the two agree to merge.
Interdependence Situations which competing firms watch one another's actions and make price
and production decisions in light of competitor decisions.
Collusion Agreeing with competing producers to avoid any action that would make the competition
Cartel An agreement not to compete between two or more producers within an industry (typically
prices and production). May agree to divide particular markets up between them so each is the main
competitor in their own section. Usually secretive firms may agree to deceive, mislead or defraud
others in order to gain competitive advantage.
Tactic Collusion When competing firms simply avoid price cutting strategies in order to eb able to
charge prices that guarantee good profits.
Price Wars Involve substantial price cuts as each competitor tries to increase market share.
What The Government Does
The Office of Fair Trading (OFT) Gathers information about the competitiveness of markets, to
respond to complains about anticompetitive practices and to ensure compliance with competition
Sunk Costs Costs that have already been paid for and cannot be recouped in the event of the
business failing to make profit and closing down.
The Competition Commission An independent public body that investigates markets where one or
more firms have become dominant, or where there are restrictive practices in operation or illegal
collusion. A dominant firm will have 25% or more market share and be a monopoly as defined by law.
Several firms acting together will be defined as complex monopoly if they have 40% or more market
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It also investigates any proposed merger that will create a firm with more than 25% of the
The Effects Of Policies And Implications For Businesses
Government Failure Occurs when government intervention makes the situation worse rather than
4.3.3b: Can The Government Control The Economy?
Macroeconomic Problems And Policies
Leakage's Reduce the demand for domestically produced goods and services by diverting part of
people's incomes into savings, taxes.
Injections Investment, government spending, export sales.…read more
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Regressive Taxes Take a higher percentage of total income from poorer people and vice versa.
Progressive Taxes Take a higher percentage of total income from the better off and vice versa. So
disposable income (income after tax) is distributed more equally, difference is then reduced.
Extending Property Rights Giving people more control over their assets.…read more