As Economics Unit 1: Efficiency And Market Failure


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3.1 Market And Resource Allocation

Main Actors In The Market:

  • Consumer - Free to spend money however they want and the market provides a wide variety of choice of products, and allocate their scarce resources so as to maximise their welfare/utility/satisfaction.
  • Firms - Try to maximise revenues and keep costs to a minimum to gain a profit from producing goods and services consumers demand.
  • Owners of the factors of production - Owners of land, labour and capital are motivated to maximise their returns on what they own.

Functions Of Prices In The Market:

  • Rationing - Uses price to act as a rationing device for scarce resources in a world where we have infinite wants.
  • Signalling - Changes in price signals consumers and produces to buy or sell more or less of a product or service.
  • Incentive - Acts as an incentive for buyers and sellers to buy and sell.
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3.2 Economic Efficiency And Market Failure

Allocative or economic efficiency: occures when resources are distributed in such a way that no consumers could be made better off without other consumers becomming worse off.

Dynamic Efficiency: Occurs when resources are allocated efficiently over time.

Productive Efficiency:  Is achieved when production is achieved at lowest cost.

Static Efficiency: Occures when resources are allocated efficiently as a point in time.

Technical Efficiency: Is achieved when a given quantity of output is produced with a minimum number of inputs.

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3.2 Economic Efficiency And Market Failure

Market Failure: Where resources are inefficiently allocated due to imperfection in the working of the market mechanism.

  • Lack of competition in a market
  • Externalities - Negative or positive spill over effects to a third party.
  • Missing markets - market fails to provide public goods or merit goods, or these are underconsumed
  • Assymetric Information
  • Factor Immobility
  • Inequality - Redistribution of income might be undesirable
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3.3 Externalities

Externaility or spill over effect: The difference between social costs and benefits and private costs and benefits. If net social costs exceeds net private cost then a negative externaility exists. If net social benefits exceeds net private benefits then a positive externaility exists.

Welfare loss triangle from production externalities:


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3.3 Externailities

Welfare loss triangle from a positive consumption externality:


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3.3 Externalities

Welfare loss triangle from negative consumption externailities:


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3.3 Externalities

Government policy to bring about efficient allocation of resources where externailities exist:

  • Regulation - Banning polluting or maximum pollution controls, minimum environmental standards.
  • Extending property rights - A method of internailising the externaility by forcing companies to pay compensation for the negative externailities they bring about.
  • Taxes - To internailise the externality to make the polluter pay the full cost of their negative externailities to society.
  • Permits - Acts to regulate and limit negative externailities.
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3.4 Public And Merit Goods

Merit Good: A good which is underprovided by the market mechanism e.g. higher education. A demerit good is one which is overprovided by the market mechanism e.g. alcohol.

Private Good: A good where consumption by one person results in the good not being available for consumption by another.

Public Good: A good where consumption by one person does not reduce the amount available for consumtion by another person and where once provided, all individuals benefit or suffer whether they wish to or not. A public good is non-rivalrous and non-excludable.

Quasi-public good: A good which may not posses perfectly the characteristics of being non-excludable but which is non-rivalrous.

Free Rider: A person or organisation which recieves benefits that others have paid for without making any contribution themselves.

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3.5 Labour Immobility

Geographical Immobility: When workers find it difficult to move from one area to another for employment. Factors which affect this include:

  • Search Costs
  • Do not wish to leave friends and family.
  • Housing

Occupational Immobility: Ability of workers to transfer from one occupation to another. Factors which affect this include:

  • Transferable skills
  • Cost of training
  • Time taken for training
  • Degree of skill required in work or tasks involved in job role.

These both mean that there si structural unemployment in the economy.

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3.5 Labour Immobility

Methods of increasing the mobility of labour:

  • Education and training
  • Relocation subsidising and housing
  • Relocating industries
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3.6 Imperfect Market Information

Asymmetic Information: Where buyers and sellers have different amounts of information of good or service being provided.

Symmetric Information: Where buyers and sellers have access to the same information of a good or service being provided.

This can have impacts on consumers who have assymetric knowledge of a good or service being provided, such as the market for second hand cars. The seller knows more about the car than the buyers. The same applies for healthcare, education, pensions and drugs.

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3.7 Market Stabilisation

Prices And Market Failure:

  • Large fluctuations in price
  • Too high a price
  • Too low a price

Maximum Prices: Price is set at PMax to enable those poorer in society to afford lower costs of renting below market equilibrium. This causes excess demand between Q1 and Q2. In the long run producers will reduce their supply.


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These 12 revision cards, go through types of market failure and the causes.



positive externalities have a welfare gain not loss

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