CH16 - Market Failures and Government Intervention

Question 1

What are the 2 approaches for defending free market?

Answer 1

1. Formal defence, based on allocative efficiency
2. Informal defence, 3 central arguments
   i. automatic coordination of actions of decentralised decision makers
   ii. Pursuit of profits provides stimulus for innov + increase living standards
   iii. Decentralisation of economic power

Question 2

What is market failure?

Answer 2

failure of the unregulated market system to achieve allocative efficiency

Question 3

When are resources allocated efficiently?

Answer 3

When P=MC

Question 4

Why does increased market power fail in free markets fail to achieve allocative efficiency?

Answer 4

Economies of scale only allow room for a few firms operating at low costs and an ability to influence the market, they sell different products, set their prices and innovate to gain temporary monopoly.
Firms w market power will maximise profit at a level of output where P>MC, which is not efficient although it is inevitable.

Question 5

What are externalities?

Answer 5

= whenever actions taken by firms or consumers directly impose costs/confer benefits on others.

Question 6

What is the relation between MB and MC for the economy to allocate efficiently?

Answer 6

MB>MC

Question 7

What is the difference between private cost and social cost?

Answer 7

Private cost - value of resources used in production as valued by producer

Social cost - includes private cost to producers plus any external costs imposed on third parties

Question 8

What are the two types of benefits?

Answer 8

Private benefit - benefit received by consumer from using product (however intangible)

Social benefit - private benef + whatever benefits accrue to third parties

Question 9

What is the effect of externalities on cost and benefits?

Answer 9

Discrepancies between private cost and social cost, or between private benefit and social benefit, occur when there are externalities. The presence of externalities, even when all markets are perfectly competitive, leads to allocatively inefficient outcomes.

Question 10

What is the effect of a positive externality?

Answer 10

With a positive externality, a competitive free market will produce too little of the good.

Question 11

What is the effect of a negatice externality?

Answer 11

With a negative externality, a competitive free market will produce too much of the good.

Question 12

What kind of good is private goods?

Answer 12

rivalrous, excludable

Question 13

what kind of goods are common-property resources

Answer 13

non-excludable, rivalrous

Question 14

what kind of goods are club goods?

Answer 14

non-rivalrous, excludable

Question 15

what kind of goods are public goods?

Answer 15

non-excludable, non-rivalrous

Question 16

What is a big problem with public goods, and how are they addressed?

Answer 16

Free-rider problem, impossible to prevent anuone from using once provided
Because of the free-rider problem, private markets will usually not provide public goods. In such situations, public goods must be provided by government

Question 17

In which 4 situations do free markets fail to achieve allocation efficiency?

Answer 17

Market Power
externalities
non-rivalrous and non-excludable goods
asymmetric information

Question 18

What is paternalism?

Answer 18

intervention in the free choices of individuals by others (including gvt) to protect them against what is presumed to be their own ignorance/folly

Question 19

What are 5 reasons the government can intervene in Free markets?

Answer 19

1. Address income distribution
2. Preferences for public provision
3. Protecting individuals from others
4. Paternalism
5. Social responsibility

Question 20

What is the leaky bucket theory?

Answer 20

Suppose we have a well-supplied reservoir of water and we want to get some water to a household that is not able to come to the reservoir. The only vessel available for transporting the water is a leaky bucket; it works, in that water can be delivered to the intended location, but it works at a cost, in that some of the water is lost on the trip. Thus, to get a litre of water to its destination, more than a litre of water has to be removed from the reservoir. It may be possible to design better or worse buckets, but all of them will leak somewhat.

The analogy to an economy is this: The act of redistribution (carrying the water) reduces the total value of goods and services available to the economy (by the amount of water that leaks on the trip). Getting a dollar to the poor reduces the resources available to everyone else by more than a dollar. Thus, pursuing social goals—like the redistribution of income—conflicts with the goal of allocative efficiency.

=Always leaky bc no wau to redistribute income w/o changing incentives for households
=Redistribution reduces overall efficiency of the market

Question 21

What is a cost-benefit analysis?

Answer 21

an approach for evaluating the desirability of a given policy, based on comparing total opportunity costs w total benefits - used only on measurable factors

Question 22

What are 3 tools for government intervention?

Answer 22

1. Public provision
2. Redistribution programs
3. Regulation

Question 23

What kinds of indirect costs occurs with gvt intervention?

Answer 23

1) Changes in costs of production
2) Costs of compliances
3) Rent seeking = private firms and special-interest groups often lobby governments for policies in their own interest but at the expense of the public interest.