Question 1

What is market failure in the context of Cambridge IGCSE Economics?

Accepted Answer

Market failure occurs when the allocation of resources by a free market is inefficient, leading to a net social welfare loss. In Cambridge IGCSE Economics, this concept is crucial as it helps students understand why markets sometimes fail to produce optimal outcomes and the role of government intervention in correcting these failures.

Question 2

How do externalities contribute to market failure?

Accepted Answer

Externalities are costs or benefits that affect third parties who are not involved in a transaction. They contribute to market failure because the market price does not reflect the true cost or benefit to society. For example, pollution from a factory imposes health costs on nearby residents, which are not accounted for in the market price of the factory's products, leading to overproduction and market failure.

Question 3

Why is public goods provision considered a market failure?

Accepted Answer

Public goods are non-excludable and non-rivalrous, meaning that one person's consumption does not reduce availability for others, and people cannot be prevented from using them. This leads to market failure because private firms cannot easily charge for their use, resulting in underproduction or no production at all. Governments often step in to provide public goods like street lighting and national defense to correct this failure.

Question 4

What role does information asymmetry play in market failure?

Accepted Answer

Information asymmetry occurs when one party in a transaction has more or better information than the other, leading to an inefficient allocation of resources. For instance, if sellers have more information about a product's defects than buyers, it can result in adverse selection and market failure. This is why regulations and consumer protection laws are important to ensure transparency and fairness in markets.

Question 5

How can government intervention address market failure?

Accepted Answer

Governments can intervene in markets to correct failures through various means such as taxation, subsidies, regulation, and provision of public goods. For example, imposing taxes on polluting activities can internalize external costs, while subsidies for education can encourage positive externalities. These interventions aim to align private incentives with social welfare, improving resource allocation.

Market Failure

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