LS17-19 - Market Failure and Externalities, Public Goods, Information Gaps

Question 1

What is external cost?

Answer 1

External cost is the cost to a third party that I snot involved in the making, buying/selling and consumption of a specific good/service

Question 2

What is external benefit?

Answer 2

External benefit is the benefit to a third party that is not involved in the making, buying/selling and consumption of a specific good/service

Question 3

What are the 3 types of market failure?

Answer 3

Externalities
Public Goods
Information Gaps

Question 4

What are externalities?

Answer 4

The consumption and production of some goods/services costs or benefits to economic agents that are not involved in the transaction

Question 5

What are public goods?

Answer 5

Some goods/services would be under-provided if provision was left entirely to the private sector

Question 6

What are information gaps?

Answer 6

Some markets have informational problems for consumers and/or producers which results in under or over consumption of the products

Question 7

What is market failure?

Answer 7

Market failure is where too much or too little of a good is produced and/or consumed compared with the socially optimal level of output
When the price mechanism leads to an inefficient allocation of resources

Question 8

What is a public good?

Answer 8

A public good is that which is non-rivalrous and non-excludable

Question 9

What is the difference between public and private goods?

Answer 9

Private goods are excludable and rivalrous

Question 10

What is a merit good?

Answer 10

Merit goods are those goods and services that the government feels that people will under-consume and so to be subsidised or provided free so consumption does not depend primarily on ability to pay

Question 11

What does non-rivalrous mean?

Answer 11

Non-rival means that consumption of a product does not prevent another person form also consuming that product

Question 12

What does non-excludable mean?

Answer 12

Non-excludable means that once a good is provided, it is impossible to stop people from using it

Question 13

What is the free-rider problem?

Answer 13

The free-rider problem is a type of market failure that occurs because everybody is able to benefit of the public goods

Question 14

Why does the free-rider problem occur?

Answer 14

Free riders are a problem because while not paying for the good, they may continue to consume. The good is then undersupplied or not provided at all

Question 15

What is the formula for social benefit and cost?

Answer 15

Social Benefits = Private Benefits + External Benefits

Social Costs = Private Costs + External Costs

Question 16

What is positive/negative externality?

Answer 16

Social benefits/costs do not equal private benefits because external benefits/costs are present

Question 17

When does the social optimal level of output occurs?

Answer 17

Where all external benefits and external costs are accounted for

Question 18

What happens in a free market when external benefits/costs are present?

Answer 18

External benefits leads to under-production/consumption in a free market

External costs lead to over-production/consumption in a free market

Question 19

What is perfect information?

Answer 19

Perfect information is when a buyer or seller has a complete understanding of the quality and nature of a good or service

Question 20

What is symmetric information?

Answer 20

Symmetric information is when buyers and seekers have equal amounts of knowledge about a good or service

Question 21

What is imperfect information?

Answer 21

Imperfect information is when a buyer or seller lacks a complete understanding of the quality and nature of a good or service

Question 22

What is asymmetric information?

Answer 22

Asymmetric information is when a buyer or seller has more information about a good or service than the other party

Question 23

What is the information gap?

Answer 23

Information gap is when either the buyer or seller does not have access to the information needed for them to make a fully-informed decision

Question 24

How do we find the marginal social cost/benefit?

Answer 24

Positive/Negative externalities are added to the firms supply/demand curve or the marginal private benefits/cost to find the marginal social benefit/cost curve

Question 25

Where is the social optimum on the cost-benefit graph?

Answer 25

The social optimum is where marginal social line crosses marginal private line
Here, negative externalities are not eliminated but the market has priced them into the product

Question 26

Where is the social welfare loss?

Answer 26

The area of the triangle formed between the free market, social optimum, and the point above market equilibrium

Question 27

Why is there social welfare loss?

Answer 27

The market output supplied is higher than the social optimum position

Question 28

How do taxes help a negative externality?

Answer 28

Tax on a product results in a fall in supply
This shifts the marginal private line to the social optimum
This partially reduces the social welfare loss

Question 29

How do subsidies help a positive externality?

Answer 29

A subsidy results in an increase in supply
This shifts the marginal private line to the social optimum
This reduces the social welfare loss