Chapter 4: Market Failures Caused by Externalities and Asymmetric Information Summary Flashcards
when does market efficiency occur?
Market efficiency occurs when resources are allocated in a way that maximizes total surplus (consumer + producer surplus).
What are the conditions for economic efficiency?
- Market demand reflects all consumers’ willingness to pay.
- Market supply includes all production costs, including external costs.
Define total surplus.
Total surplus is the sum of consumer surplus and producer surplus, representing the net benefits to society from resource allocation.
What is consumer surplus?
The difference between the maximum price consumers are willing to pay and the actual market price.
What is producer surplus?
The difference between the actual price producers receive and the minimum price they would accept to supply a good.
What happens when marginal benefit equals marginal cost?
Allocative efficiency is achieved, maximizing total surplus.
What are externalities?
Externalities are costs or benefits that affect third parties not involved in a market transaction.
What are negative externalities?
Costs imposed on third parties (e.g., pollution) leading to overproduction and resource overallocation.
What are positive externalities?
Benefits received by third parties (e.g., vaccinations) leading to underproduction and resource underallocation.
What role does government play in addressing externalities?
Governments can implement direct controls, Pigovian taxes, subsidies, or provide public goods to improve resource allocation.
Define asymmetric information.
A situation where one party in a transaction has more or better information than the other, potentially leading to market failure.
What is moral hazard?
when a person behaves more recklessly after obtaining a contract that shifts the costs of bad outcomes onto another party, such as an insurance company or the government.
Examples: A truck driver starts speeding and passing aggressively after obtaining auto insurance because he knows that if he wrecks, the insurance company will be stuck with the bill
what is the adverse selection problem?
A situation where high-risk individuals are more likely to purchase insurance, resulting in a risk-heavy insurance pool.
what is a market failure?
The 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 because of externalities or asymmetric information, or because markets fail to provide desired public goods.
what is consumer surplus?
the difference between the price a consumer is willing to pay for a product and the price they actually pay
