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A A E Chapter 4
Market Failures Caused by Externalities and Asymmetric Information
| Term | Definition |
|---|---|
| Market Failure | Inability of a market to bring about the allocation of resources that best satisfies the wants of society, in particular the overallocation or underallocation of resources to the production of a particular good or service |
| Market Failure Causes | Externalities, asymmetric information, or market failure to provide desired public goods |
| Total Surplus (Social Welfare) | Sum of consumer surplus and consumer surplus Want to maximize for market efficiency |
| Sonsumer Surplus | Difference between max consumer is willing to pay for an additional unit of a product and its market price Lower prices = higher surpluses |
| Producer Surplus | Difference between actual price a producer receives and minimum acceptable price |
| Productive Efficiency | Production of a good in the least costly way Occurs when production takes place at the output level at which per unit production costs are minimized |
| Allocative Efficiency | Apportionment of resources among firms and industries to obtain the production of products most wanted by society |
| Deadweight Losses | Reductions in combined consumer and producer surplus caused by an under allocation or overallocation of resources to the production of a good or service |
| Externality | A cost or benefit from production or consumption that accrues to someone other than the immediate buyers and sellers of the product being produced or consumed |
| Negative Externalities | Cost imposed without compensation on third parties by production or consumption of sellers or buyers |
| Negative Externalities Example | Manufacturer dumps toxic chemicals into a river, killing fish prized by sports fishers |
| Positive Externalities | Benefit obtained without compensation of third parties from the production or consumption of sellers or buyers |
| Free-Rider | Someone who benefits without paying for the good or service |
| Positive Externality Example | Beekeeper next to an apple orchard, helps them both Vaccines- Person getting one won't get sick and he can't infect anyone else |
| Government Intervention | May achieve economic efficiency when externalities affect large numbers of people or when community interests are at stake |
| Direct Controls | Government policies that directly constrain activities that generate negative externalities |
| Direct Controls Example | Max emissions limits for factory smokestacks and laws mandating proper disposal of toxic waste |
| Direct Controls Effect | Raises MC of production Shifts S curve upwards (L) and increases equilibrium price |
| Pigouvian Taxes | A tax or charge levied on the production of a product that generates negative externalities |
| Pigouvian Taxes Example | US government has put a tax on CFCs and producers decide whether to pay it or to spend money researching alternatives |
| When Spillover Benefits are Large, Government Can... | Subsidies to Buyers Subsidies to Producers Government Provision |
| Subsidies to Buyers | Government corrects underallocations by subsidizing consumers of the product |
| Subsidies to Buyers Effects | Shifts D curve to appropriate amount and number rises to optimal Eliminates efficiency loss |
| Subsidies to Producers | Decreases producer cost |
| Subsidies to Producers Effects | Shifts S curve upward Output increases to optimal level, corrects efficiency loss |
| Government Provision | When positive externalities are extremely large, government can provide the product free to everyone |
| Government Provision Example | Vaccines for all in US are free |
| Shifts of MB and MC Curves | Change over time with societal change |
| Government's Role in the Economy | Economic role of the government, although critical to well functioning economy isn't always perfectly carried out |
| Asymmetric Information | A situation where one party to a market transaction has more information about a product or service than the other |
| Asymmetric Information Results | Under or over allocation of resources Makes it hard to distinguish trustworthy buyers and sellers |
| Moral Hazard Problem | Possibility that individuals or institutions will behave more recklessly after they obtain insurance or similar contracts that shift the financial burden of bad outcomes onto others |
| Moral Hazard Problem Examples | Bank whose deposits are insured against losses may make riskier loans and investments Drivers with car insurance drive more recklessly |
| Adverse Selection Problem | Problem arising when information known to one party to a contract or agreement is not known to the other party, causing the latter to incur major costs |
| Adverse Selection Problem Examples | individuals who have the poorest health are the most likely to buy health insurance Someone planning to commit arson on their house gets home insurance |
| Private Sector Information Problems | Private sector can't remedy all problems, in some situations, government intervention is desired to promote an efficient allocation of society's scarce resources |
Created by:
Eliana.s
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