Government Intervention Flashcards
3 examples of market failures
- Market power
- Asymmetric information
- Externality
Gov strategies for market power
Taxes won’t help since firms are producing too little
- Make sure there is competition
- prevent mergers
- collusion/cartels illegal - Price regulation e.g. landlines, power grid
2 ways asymmetric info arises
- Adverse selection (hidden info about product quality)
2. Moral hazard (hidden action - lack of incentive to guard against consequence)
Difference between imperfect and asymmetric info
Imperfect is when neither of us are sure
The fairness of a bet depends on
expected value - outcome is weighted by probability of occurance
Riskiness depends on
variance of the bet
The law of large numbers says that
as the sample size grows,
the average result gets closer to the expected value
What happens if there’s common knowledge about value for buyers and sellers?
Separating equilibrium where different goods are treated differently
What happens if there’s imperfect knowledge about value for buyers and sellers?
Pooling equilibrium - goods of different quality treated the same -> more low quality goods
3 effects of an externality
- missing market
- no longer produce an efficient outcome
- social optimum doesn’t equal private optimum
How can social factors lead to negative externalities?
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
How can governments respond to negative externalities?
– Impose a tax
– Impose a quota
– Establish a market or establish clear property rights
A “Pigovian Tax” raises
the price of the good by the amount of the externality,
discouraging its consumption / production just enough to reach the social optimum
A quota (if correctly set) means that
no-one is allowed to produce beyond the point where the marginal social cost of the good exceeds its marginal benefit
Governments can create markets by
emitting tradable permits
Who are excludables?
those who do not pay for the use of a good can be prevented from using it
Who are rivals?
one person’s use of the good diminishes another person’s
ability to use it
4 key factors of Club Goods
- High fixed cost, low MC
- Increasing returns to scale
- Natural monopoly
- Subject to government ownership/price regulation
2 key factors of common resources
- Non-excludable, rival
2. Consumption leads to negative externalities
Typical solutions to common resource problems
- Charge for use
- Impose quota
- Establish clear rights
2 key factors of public goods
non-rival and non-excludable
Purchase of good has positive externalities
Typical solutions to public goods problem
government provides the good
Payment through taxation or compulsory contributions
