Chapter 16: Market Failures Flashcards
Monopoly of violence
The government’s control over all physical violence that is employed to enforce its laws and policies
3 defences of free markets according to Adam Smith
- Free markets co-ordinate the actions of decentralised decision makers
- The pursuit of profits in free markets provides a stimulus to innovation and rising material living standards
- Free markets permit a decentralisation of economic power
Market failure
Failure of the unregulated market system to achieve unregulated allocative efficiency
Externality
An effect on parties not directly involved in the production or use of a commodity
Private cost
The value of the best alternative use of resources used in production as valued by the producer
Social cost
The value of the best alternative use of resources used in production as valued by society
Externalities cause _____
Discrepancies between private cost and social cost
With a positive externality, a competitive free market will produce too ____ of a good
Little
With a negative externality, a competitive free market will produce too ____ of a good
Much
Rivalrous good or service, 1 example
A good or service is rivalrous if one person’s consumption of it reduces the amount available for others
-Any food
Excludable good or service, 1 example
A good or service is excludable if its owner can prevent others from consuming it
-Chocolate bar (any good that must be purchased before use)
Private good or service, 1 example
Both excludable and private
-Aeroplane seat (any good that must be purchased before use, and cannot be used by anyone else)
Common-property resource, 1 example
Rivalrous but not excludable
-Clean air (any good that cannot be used by anyone else, but use cannot be regulated)
Club good or service, 1 example
Excludable but not rivalrous
-Roads (any good that can be used my anyone at any time, but use can be regulated)
Public good or service, 1 example
Non-excludable and non-rivalrous
-National defence
The optimal quantity of a public good is such that the marginal cost of the good equals ___________
The sum of all users’ marginal benefits of the good
Asymmetric information
A situation in which one party to a transaction has more or better relevant information about the transaction than the other party
Two sources of market failure arising from asymmetric information
- Moral hazard
- Adverse selection
Moral hazard
A situation in which an individual or a firm takes advantage of special knowledge while engaging in socially inefficient behaviour
Adverse selection
Self-selection, within a single risk category, of persons of above-average risk e.g. an individual with a heart condition taking out additional health insurance coverage without a medical examination
Even in the absence of market failures, the government may choose to intervene in markets to achieve ________
Broader social goals
Paternalism
Intervention in the free choices of individuals by others to protect them against (what is presumed to be) their own ignorance or folly
Cost-benefit analysis
An approach for evaluating the desirability of a given policy, based on comparing total (opportunity) costs with total benefits
Rent seeking
Private firms and individuals trying to use the powers of the government to enhance their own economic well-being in ways that are not in the social interest
Rational ignorance
When agents have no incentive to become informed about a government policy because the cost of doing so would exceed the benefits of any well-informed action the agent might take
