2.7 - 2.8

Question 1

Non-Excludability and Non-Rivalry (features of public goods)

Answer 1

Public Goods are goods that are both non-excludable and non-rivalrous.
Non-excludable: People cannot be easily prevented from using the good.
Non-rivalrous: One person’s use of the good does not reduce the availability of the good for others.
Example: National Defense – No one can be excluded from being protected by national defense, and one person benefiting from defense does not reduce the protection others receive.
Example: Street Lighting – Everyone can benefit from street lighting without being excluded, and one person using the light doesn’t reduce its availability to others.

Question 2

The Free Rider Problem

Answer 2

Definition: Occurs when individuals can enjoy a good or service without paying for it, leading to under-provision or no provision of that good.
Example: Public Parks – People can use public parks without directly paying for their upkeep, resulting in less incentive for individuals or companies to maintain them, as others can benefit for free.
Example: Open-Access Beaches – Individuals can freely access and use the beach without contributing to its maintenance, leading to overuse and lack of care.

Question 3

The Tragedy of the Commons

Answer 3

Definition: Occurs when individuals overuse and deplete a common resource due to self-interest, even though it is in the group’s long-term interest to conserve the resource.
Example: Overfishing – Since no one owns the ocean or regulates it adequately, many fishermen may overfish, leading to depletion of fish stocks, even though sustainable fishing would benefit everyone in the long run.
Example: Deforestation – In a shared forest where no one has exclusive ownership, individuals might cut down too many trees, causing environmental degradation because they prioritize short-term personal gains over long-term sustainability.

Question 4

Adverse Selection

Answer 4

Definition: Occurs when one party in a transaction has more or better information than the other, leading to poor decision-making or inefficiencies.
Example: Health Insurance – Insurance companies may not know the true health status of applicants. People who are sick (high-risk) are more likely to buy insurance, while healthy individuals (low-risk) may avoid it. This leads to higher premiums, as insurers cannot differentiate between high-risk and low-risk individuals.
Example: Used Car Market (The “Lemon” Problem) – Sellers of used cars know more about the condition of the vehicle than buyers. As a result, buyers may assume that all used cars are of lower quality and offer lower prices, leading to fewer high-quality cars being sold.

Question 5

Moral Hazard

Answer 5

Definition: Occurs when one party takes on more risk because they do not bear the full consequences of their actions, often due to asymmetric information.
Example: Bank Bailouts – Banks might take on excessive risk because they believe the government will bail them out if they fail. Since they do not bear the full consequences of risky behavior, they may engage in even riskier activities.
Example: Car Insurance – After purchasing insurance, a person may drive more recklessly because they know the insurance company will cover the cost of damages, transferring the risk to the insurer.