Macro 1.3 Flashcards
What is market failure?
Market failure occurs when the free market fails to allocate resources to the best interests of society, leading to an inefficient allocation of scarce resources.
Economic and social welfare is not maximized where there is market failure.
What are the types of market failure?
- Externalities
- Under-provision of public goods
- Information gaps
Define externality.
An externality is the cost or benefit a third party receives from an economic transaction outside of the market mechanism.
What is the free-rider problem?
The free-rider problem occurs when public goods are non-excludable and non-rival, leading to individuals benefiting without paying.
What are private costs?
Private costs are the costs to economic agents involved directly in an economic transaction.
Define social costs.
Social costs are calculated by private costs plus external costs, representing the cost to society as a whole.
What is the social optimum position?
The social optimum position is where marginal social costs (MSC) equal marginal social benefits (MSB), indicating maximum welfare.
True or False: External costs increase disproportionately with increased output.
True
What are external benefits of consumption?
External benefits of consumption are positive effects on third parties from the consumption of a good or service.
What is the purpose of indirect taxes in relation to negative externalities?
Indirect taxes aim to reduce the quantity of demerit goods consumed by increasing the price of the good.
Fill in the blank: Public goods are _______ and _______.
non-excludable, non-rival
What are quasi public goods?
Quasi public goods have characteristics of both public and private goods, being partially provided by the free market.
Define asymmetric information.
Asymmetric information occurs when there is unequal knowledge between consumers and producers, leading to market failure.
What is the effect of imperfect information on economic decisions?
Imperfect information leads to a misallocation of resources as informed decisions cannot be made.
What is the relationship between private benefit and private costs?
Private benefit is derived from the consumption of a good and is influenced by the price the consumer is willing to pay.
What are social benefits?
Social benefits are private benefits plus external benefits, reflecting the total benefit to society from consumption.
What is deadweight welfare loss?
Deadweight welfare loss occurs when the output where social costs exceed private benefits is not accounted for, leading to inefficiency.
What role do property rights play in market efficiency?
Property rights encourage innovation as entrepreneurs can protect their ideas and earn profit.
What is a common challenge in measuring public goods?
It is difficult to measure the value consumers get from public goods, making it hard to assign a price.
True or False: Negative externalities can lead to over-provision and under-pricing of goods.
True
What is the significance of consumer information in economic decisions?
Providing information ensures that there is no information failure, allowing informed economic decisions.
What are the implications of government policies on externalities?
- Indirect taxes to reduce demerit goods
- Subsidies to encourage merit goods
- Regulation to enforce less consumption
What happens when external costs are not internalized in the market?
The market fails to account for negative externalities, leading to social costs exceeding social benefits.
Fill in the blank: Consumers may undervalue the benefit of a public good, leading them to pay _______.
less
What is asymmetric information?
A situation where one party has more or better information than another, leading to misallocation of resources.
This often affects consumers and producers differently in market transactions.
What can result from imperfect information?
Misallocation of resources, consumers paying too much or too little, and firms producing the incorrect amount.
An example includes monopolies exploiting consumers by overcharging.
Define the principal-agent problem.
A situation where an agent makes decisions on behalf of a principal but acts in their own interests rather than those of the principal.
This often occurs between shareholders and managers.
What is a consequence of the principal-agent problem?
Managers may prioritize personal gain over maximizing shareholder dividends.
This can lead to conflicts of interest within a company.
How can information be made more widely available?
Through advertising or government intervention.
For instance, public health messages about smoking can inform consumers.
What is moral hazard?
When a party with superior knowledge changes their behavior to benefit themselves at the expense of another party with inferior knowledge.
This is commonly observed in insurance markets.
True or False: Asymmetric information can lead to moral hazard.
True.
Moral hazard arises when one party’s superior information results in changes in behavior that disadvantage another party.
Fill in the blank: Asymmetric information can lead to _______ where consumers are unaware of the true costs or benefits.
misallocation of resources.
What might consumers know more about than producers when purchasing insurance policies?
The risks associated with their own health or circumstances.
This knowledge imbalance can affect insurance pricing and availability.
