Efficiency and Market Failure | Externalities

Question 1

Economic Efficiency

Answer 1

Scare resources are used in the most efficient way

Question 2

Productive Efficiency

Answer 2

When a firm is producing at the lowest possible cost

Question 3

Allocative efficiency

Answer 3

When price = Marginal cost, firms producing goods in high demand

Question 4

Marginal cost

Answer 4

Addition to total cost when making one extra unit of output

Question 5

Conditions for Productive efficiency

Answer 5

1. Economy is producing at boundary of PPC
2. Competition can lead to productive efficiency

Question 6

Conditions for Allocative efficiency

Answer 6

1. The desire to make the greatest profit
2. Competition leads to allocative efficiency

Question 7

Pareto optimality

Answer 7

Impossible to make someone better off without making the other worse off

Question 8

Dynamic efficiency

Answer 8

When resources are allocated efficiently over time

Question 9

Reasons for market failure

Answer 9

1. Where there are externalities in the market
2. Provision of demerit and merit goods
3. Provision of public and quasi-public goods
4. Information failure
5. Moral Hazard and adverse selection
6. Abuse of monopoly power

Question 10

Policies to correct externalities

Answer 10

1. Taxes
2. Subsidies
3. Regulations
4. Pollution permits
5. Property rights
6. Provision of information

Question 11

Policy for Negative consumption

Answer 11

1. Taxes
2. Price controls / Provision of information / quotas

Question 12

Policy for Positive Production

Answer 12

Subsidies and provision of information

Question 13

Private Costs

Answer 13

Costs incurred by consumer/firm

Question 14

External Costs

Answer 14

Costs incurred and paid for by the third party

Question 15

Social Costs

Answer 15

Total costs of an economic decision

Question 16

Tip

Answer 16

When private costs = Social cost, then there are no externalities

Question 17

Deadweight loss

Answer 17

Loss in welfare due to inefficient resource allocation

Question 18

Adverse selection

Answer 18

Sellers have information that buyers do not or when buyers have information sellers don’t have

Question 19

Moral Hazard

Answer 19

Temptation to take risks when other party is covering the risk

Question 20

Cost-benefit analysis

Answer 20

Decision-making that considers costs and benefits of an action

Question 21

Cost-benefit analysis

Answer 21

1. Identification
2. Attach monetary value
3. Forecasting future costs/benefits
4. Decision making