Unit 1 Micro: Market Failure Glossary

This blog provides a glossary of many key market failure terms

Absolute poverty
The number of people living below a certain income threshold or the number of households unable to afford certain basic goods and services. The United Nations definition is a severe and persistent deprivation of basic human needs

Adverse selection
Where the expected value of a transaction is known more accurately by the buyer or the seller due to an asymmetry of information; e.g. health insurance

Asymmetric information
Occurs when somebody knows more than somebody else in the market. Such asymmetric information can make it difficult for the two people to do business together. A situation in which some agents have more information than others and this affects the outcome of a bargain between them

Common resources
Goods or services that have characteristics of rivalry in consumption and non-excludability - grazing land or fish stocks are examples. The over-exploitation of common resources can lead to the “tragedy of the commons”

Deadweight loss of welfare
The loss in producer and consumer surplus due to an inefficient level of production perhaps resulting from market failure or government failure

De-Merit goods
The consumption of de-merit goods can lead to negative externalities which causes a fall in social welfare. The government normally seeks to reduce consumption of de-merit goods. Consumers may be unaware of the negative externalities that these goods create - they have imperfect information.

External cost
External costs are those costs faced by a third party for which no appropriate compensation is forthcoming. Identifying and then estimating a monetary value for air and noise pollution is a difficult exercise - but one that is increasingly important for economists concerned with the impact of economic activity on our environment.

Externalities are third party effects arising from production and consumption of goods and services for which no appropriate compensation is paid.

Geographical immobility
People may also experience geographical immobility – meaning that there are barriers to them moving from one area to another to find work

Gini Coefficient
The Gini coefficient measures the extent to which the distribution of income (or, in some cases, consumption expenditures) among individuals or households within an economy deviates from a perfectly equal distribution. The coefficient ranges from 0 -meaning perfect equality -to 1- complete inequality.

Information Failure
Information failure occurs when people have inaccurate, incomplete, uncertain or misunderstood data and so make potentially ‘wrong’ choices

Market Failure
Market failure exists when the competitive outcome of markets is not efficient from the point of view of the economy as a whole. This is usually because the benefits that the market confers on individuals or firms carrying out a particular activity diverge from the benefits to society as a whole

Market Power
Market power refers to the ability of a firm to influence or control the terms and condition on which goods are bought and sold. Monopolies can influence price by varying their output because consumers have limited choice of rival products.

Merit Good
A merit good is a product that society values and judges that everyone should have regardless of whether an individual wants them. In this sense, the government (or state) is acting paternally in providing merit goods and services

Moral hazard
When people take actions that increase social costs because they are insured against private loss: sometimes it is called hidden action due to the agent’s actions being hidden from the principal.

Negative externality
Negative externalities occur when production and/or consumption impose external costs on third parties outside of the market for which no appropriate compensation is paid. This causes social costs to exceed private costs

Non-rival consumption
Non-rivalry means that the consumption of a good by one person does not reduce the amount available for others. An example could be air. Non-rivalry is one of the key characteristics of a public good

Positive externalities
Positive externalities exist when third parties benefit from the spill-over effects of production/consumption e.g. the social returns from investment in education & training or the positive benefits from health care and medical research.

Poverty trap
The poverty trap affects people on low incomes. It creates a disincentive to look for work or work longer hours because of the effects of the tax and benefits system

Public bads
Public bads include environmental damage and global warming which affects everyone – no one is excluded from the dis-benefits

Public goods
Pure public goods are non-rival – consumption of the good by one person does not reduce the amount available for consumption by another person, and non-excludable – Where it is not possible to provide a good or service to one person without it thereby being available for others to enjoy.

Relative poverty
Relative poverty measures the extent to which a household’s financial resources falls below an average income threshold for the economy

Social benefit
The benefit of production or consumption of a product for society as a whole. Social benefit = private benefit + external benefit

Social cost
The cost of production or consumption of a product for society as a whole. Social cost = private cost + external cost

Spillover effects
External effects of economic activity, which have an impact on outsiders who are not producing or consuming a product – these can be negative (creating external costs) or positive (creating external benefits)

Tragedy of the Commons
When no one owns a resource, it gets over-used, for example fish stocks and deforestation - people use and benefit from it without regard to the effect on others









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