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QUESTION 5: MICROECONOMICS - Discuss in detail the causes of market failure - NSC Economics - Question 5 - 2024 - Paper 2
Question 5
QUESTION 5: MICROECONOMICS - Discuss in detail the causes of market failure. - Analyse the impact of minimum prices in the economy.
Worked Solution & Example Answer:QUESTION 5: MICROECONOMICS - Discuss in detail the causes of market failure - NSC Economics - Question 5 - 2024 - Paper 2
Step 1
Discuss in detail the causes of market failure.
Answer
Market failure occurs when the forces of supply and demand fail to allocate resources efficiently. Key causes include:
Externalities
- Externalities: Costs or benefits affecting third parties not included in the market price. For instance, pollution from a factory impacts nearby residents who do not engage in the transaction.
- Positive externality: Education benefits society, but not everyone contributes to funding.
- Negative externality: Overproduction of goods causing pollution, which harms public health.
Missing Markets
- Missing Markets: Certain goods or services are not provided because they're not profitable for producers, such as public goods like street lighting.
Information Asymmetry
- Information Asymmetry: When consumers or producers lack information, it leads to poor decisions. For example, buyers may overpay for products or produce less than optimal output.
Immobility of Factor Inputs
- Immobility of Factors of Production: Labor cannot be easily relocated, affecting market efficiency. Workers may lack skills for new jobs, creating unemployment.
Market Power
- Imperfect Competition: When monopolies or oligopolies exist, they can manipulate prices and output levels, leading to inefficiencies in the market.
Inequality of Income and Wealth
- Inequitable Distribution of Income: This can lead to market failure as consumers with less income cannot participate in the economy, reducing overall demand.
Step 2
Analyse the impact of minimum prices in the economy.
Answer
Minimum prices, such as price floors, have significant impacts:
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Surplus Creation: If a minimum price is set above the equilibrium, it can lead to excess supply. For instance, farmers may produce more crops than consumers purchase at the higher price.
- Example: The government might set a minimum price for agricultural products leading to surplus.
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Increased Prices: Consumers may face higher prices due to minimum pricing, reducing affordability and overall demand.
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Living Standards: Households may struggle to meet expenses if prices rise beyond their means, thus decreasing the standard of living.
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Black Market Potential: High minimum prices can encourage black markets where goods are sold below the legal minimum, undermining the intended effects of policy.
The objective of minimum pricing is often aimed at ensuring producers receive fair compensation but must be balanced against potential negative consequences.