6_Market Failure

Question 1

Reasons for market failures:

Answer 1

Public goods, externalities, imperfect competition, asymmetric information, (bounded rationality) etc.

Question 2

Public goods can be characterized by:

Answer 2

1. Non-rivalry (in consumption)
   
   • The use of the good by one individual does not influence the amount of the good available for others to enjoy
     
     • Consequence: market provides less than the optimal quantity
2. Non-excludability (in consumption)
   
   • It is impossible (or prohibitively costly) to exclude individuals from consuming the public good
     
     • Consequence: free-riding
3. • Lighthouse, street lightning, national defense, radio waves (programs), clean air, climate

Question 3

rivalry, non-rivalry, excludable, non-excludable

Answer 3

Question 4

How to provide a public good

Answer 4

Public provision (government) could pay

• (subsidize) supply of 16 hours (public Radio)
• We have optimal (efficient) quantity
• But, how can it be financed?
  
  • General tax
    
    • Problem: Contributors are not
      necessarily beneficiaries. Some will
      pay more than their benefits and
      some less. Fair?
    • Introducing or increasing a tax also
      causes deadweight losses in the
      administration
  • Different solution: Charge 50 as an entrance
    fee and everybody can listen as much as he /she wants -> Club good

Question 5

Externality

Answer 5

“The effect than an action of any decision marker has on the well-being of other individuals beyond the effects transmitted through prices”

• Positive vs negative externalities (external benefits or external cost)
• Externalities in consumption vs production
• Examples:
  
  • (NP) Smokestack emissions of factories or effluent dumped into a river
  • (PP) Cultivated landscape
  • (NC) smoking of cigarettes -> nonsmokers don’t like it
  • (PC) Vaccination against epidemic diseases -> prevents others from getting sick

Question 6

Problem der Allmende

Answer 6

• “Allmende” is a commonly owned pasture for cattle or sheep herd
  
  • Agents see only their own revenue/profit -> add more cattle (act individually rational)
  • If everybody acts this way grazing land becomes overused, the sward destroyed, soil erosion -> each person wants the best for themselves, but bad for society
• Over usage of a common pool resource
• Other example: overfishing of the sea or rivers

Question 7

The prisoners’ dilemma

Answer 7

• Game theory: attempts to mathematically capture behavior in strategic situations, in which an individual’s success in making choices depends on the choices of others
• Players can choose between different actions (strategies) and try to maximize their pay-offs, i.e. behave rational
• Nash-equilibrium: solution concept in game theory
  
  • If each player has chosen a strategy and no player can benefit by changing his or her strategy while the other players keep theirs unchanged, then the current strategy choices and the corresponding payoffs constitute a Nash equilibrium.
• Original prisoners dilemma
  
  • 2 prisoners who have committed a capital crime
  • If both stay silent -> 1 year each for the crime
  • Chief witness goes free