MARKETS

Information failure

Question 1

Information failure is one of the most widespread market failures. Asymmetric information means that one party, usually the seller, has more information than the buyer, and can exploit the situation. Briefly explain the information failure associated with the following markets, and how asymmetric information may be exploited.

1. The market for cosmetics

2. Weight loss diets

3. Dental treatment

4. Cigarettes

Question 2

With reference to the above cases, explain what governments can do, if anything, to reduce information failure?

Question 3

1. What is a de-merit good?

2. Explain why they are likely to be ‘too many’ de-merit goods in a free market economy. 

3. Use a diagram to help explain the ‘net welfare loss’ arising from the free market consumption of de-merit goods. 

4. Taking the case of alcohol consumption by young people, explain and evaluate any three remedies to help reduce alcohol consumption.

Question 4

Read the following data.  

 ‘…fish stocks are running low and politicians need to act now…’ Said a recent headline. There was a time when fish was a cheap source of food and regularly eaten as part of the British national diet – most foreigners have heard of British Fish and Chips, though sadly these have been largely replaced by Big Macs and Fries. Politicians seem to have little answers, and they have turned increasingly to economists to provide an explanation, as well as offer solutions. Economists refer to the depletion of fish stocks as an example of market failure – although any economist will tell you that there is more than one market failure associated with low fish stocks. Economists argue that free markets do not always allocate scarce resources optimally, and running out of fish can be blamed on the failure of markets to find a solution.

Urban congestion is a similar problem that needs to be resolved. In the case of congestion, many economists argue that government should intervene through heavy regulation, such as banning cars from city centres, while other economists still believe that markets can solve the problem, but that governments should ‘manipulate market forces’ so that they can send out the right signals. Road pricing would be an example of ‘using the market’ to help solve the problem. The same logic can be applied to depletion of fish stocks - for example, ‘banning’ the catching of certain types of fish or subsidizing fish farms which might ‘manipulate the market’ to encourage new entrants, or to reduce costs for existing fish farmers.  

1. What is meant by ‘a socially optimal allocation of scarce resources’? (4)

2. Briefly contrast ‘manipulating market forces’ and ‘regulation’ as remedies for urban congestion. (4)

3. Explain the reasons for the depletion of fish stocks, from the economist’s perspective. (10)  

4. With a diagram illustrate the concept of net welfare loss associated with over-fishing. (6)

5. Evaluate policies designed to reduce the depletion of fish stocks in the EU. (16)