Government Intervention

Question 1

3 examples of market failures

Answer 1

1. Market power
2. Asymmetric information
3. Externality

Question 2

Gov strategies for market power

Answer 2

Taxes won’t help since firms are producing too little

1. Make sure there is competition
   - prevent mergers
   - collusion/cartels illegal
2. Price regulation e.g. landlines, power grid

Question 3

2 ways asymmetric info arises

Answer 3

1. Adverse selection (hidden info about product quality)

2. Moral hazard (hidden action - lack of incentive to guard against consequence)

Question 4

Difference between imperfect and asymmetric info

Answer 4

Imperfect is when neither of us are sure

Question 5

The fairness of a bet depends on

Answer 5

expected value - outcome is weighted by probability of occurance

Question 6

Riskiness depends on

Answer 6

variance of the bet

Question 7

The law of large numbers says that

Answer 7

as the sample size grows,

the average result gets closer to the expected value

Question 8

What happens if there’s common knowledge about value for buyers and sellers?

Answer 8

Separating equilibrium where different goods are treated differently

Question 9

What happens if there’s imperfect knowledge about value for buyers and sellers?

Answer 9

Pooling equilibrium - goods of different quality treated the same -> more low quality goods

Question 10

3 effects of an externality

Answer 10

1. missing market
2. no longer produce an efficient outcome
3. social optimum doesn’t equal private optimum

Question 11

How can social factors lead to negative externalities?

Answer 11

A competitive market will produce too much of a good with a negative externality

The firm takes private costs into account when deciding how much to produce – but not social cost

Question 12

How can governments respond to negative externalities?

Answer 12

– Impose a tax
– Impose a quota
– Establish a market or establish clear property rights

Question 13

A “Pigovian Tax” raises

Answer 13

the price of the good by the amount of the externality,

discouraging its consumption / production just enough to reach the social optimum

Question 14

A quota (if correctly set) means that

Answer 14

no-one is allowed to produce beyond the point where the marginal social cost of the good exceeds its marginal benefit

Question 15

Governments can create markets by

Answer 15

emitting tradable permits

Question 16

Who are excludables?

Answer 16

those who do not pay for the use of a good can be prevented from using it

Question 17

Who are rivals?

Answer 17

one person’s use of the good diminishes another person’s

ability to use it

Question 18

4 key factors of Club Goods

Answer 18

1. High fixed cost, low MC
2. Increasing returns to scale
3. Natural monopoly
4. Subject to government ownership/price regulation

Question 19

2 key factors of common resources

Answer 19

1. Non-excludable, rival

2. Consumption leads to negative externalities

Question 20

Typical solutions to common resource problems

Answer 20

1. Charge for use
2. Impose quota
3. Establish clear rights

Question 21

2 key factors of public goods

Answer 21

non-rival and non-excludable

Purchase of good has positive externalities

Question 22

Typical solutions to public goods problem

Answer 22

government provides the good

Payment through taxation or compulsory contributions