Chapter 4: Market Failures, Public Goods And Externalities

Question 1

Demand-side market failures

Answer 1

• impossible to charge consumers what they wanna pay

- they can get benefits for free

Question 2

Supply-side failures

Answer 2

• firm doesn’t have to pay full cost of production

- external costs of production aren’t reflected in the supply

Question 3

Factors of efficiently functioning markets

Answer 3

1- the demand curve must show the consumers’ full willingness to pay
2- supply curve must show full production costs

Question 4

If the conditions of an efficient market hold…

Answer 4

The market will produce only units where benefits are equal to costs and maximize the amount of “benefit surpluses” that are shared between consumers and producers

Question 5

Consumer surplus

Answer 5

• Difference between what a consumers willing to pay and what they actually pay
• extra benefit from paying less than max price

Question 6

Producer surplus

Answer 6

• difference between the actual price a producer receives and the minimum price they’d accept
• extra benefit from receiving a higher price

Question 7

Productivity efficiency is achieved by

Answer 7

Producers using the best technologies and combinations of resources available, minimizing the per-unit-cost of the output produced

Question 8

Allocative efficiency

Answer 8

Correct quantity of products is produced relative to other goods and services

Question 9

Allocative efficiency occurs at the market equilibrium quantity with 3 conditions existing…

Answer 9

1- MB (marginal benefit)= MC (marginal cost)
2- max willingness to pay= minimum acceptable price
3- total surplus (consumer and producer surplus) is at max

Question 10

Private goods

Answer 10

• offered for sale in stores
• rivalry (one person buys another can’t have that product)
• excludability (people who don’t pay get no benefit)
• no underproduction or overproduction

Question 11

Public goods

Answer 11

• provided by government for free
• nonrivalry
• nonexcludability
• free-rider problem (nonpayers enjoy benefit)

Question 12

Free riding

Answer 12

• willingness to pay of free riders not expressed in market
• more free riding less demand
• lack of demand means private firms can’t profit from public goods
• private firms don’t produce them so society suffers efficiency losses (the goods’ mb exceeds mc)
• if the private firms can afford the production costs, they’ll produce them

Question 13

How does society determine the optimal amount of a public good if they can’t see the demand for it?

Answer 13

• the government has to try and estimate the demand with surveys/votes
• mb must = mc

Question 14

Cost-benefit analysis

Answer 14

Comparison of marginal costs and benefits

Question 15

Cost of public goods

Answer 15

• resources diverted from private good production

- private goods that won’t be produced

Question 16

Benefit of public goods

Answer 16

Extra satisfaction

Question 17

Economy in government is not…

Answer 17

Reduced government spending

Question 18

Economy in government is…

Answer 18

Allocating resources between private and public sectors to achieve max net benefit

Question 19

Quasi public goods

Answer 19

-Government-provided goods and services that could possibly exclude

Question 20

Reallocation system

Answer 20

Government uses taxes to reallocate resources from private goods to production of quasi and public goods

Question 21

Externalities

Answer 21

Cost or benefit accruing to a third party that is external to the market transaction

Question 22

Negative externalities

Answer 22

• detrimental effects
• too much produced
• supply side failures

Question 23

Positive externalities

Answer 23

• effects benefit
• too little produced
• demand side failures

Question 24

How does government correct negative externalities?

Answer 24

1- private bargaining
2- liability rules and lawsuits
3- tax on producers
4- direct controls
5- market for externality rights

Question 25

How does the government correct positive externalities?

Answer 25

1- private bargaining
2- subsidy to consumers
3- subsidy to producers
4- government provision

Question 26

Direct controls

Answer 26

Pass legislation to limit activity (I.e. Raise cost of production)

Question 27

Government role in economy

Answer 27

• correction of externalities
• officials must identify existence and cause
• has to be done in context of politics