Market Efficiency

Question 1

What is market failure?

Answer 1

When markets allocate resources in Pareto-inefficient ways

Question 2

What are the three conditions required for markets to work well?

Answer 2

Private property: the right to own the thing bought/sold
Institutions: the governments have to enforce property rights
Social norms: people have to respect property rights

Question 3

When do markets fail?

Answer 3

When property rights are missing, incomplete, or hard to enforce with a contract

Question 4

What are the three causes of market failure?

Answer 4

External effects
Asymmetric information
Incomplete contracts

Question 5

What is an external effect?

Answer 5

An effect of an economic decision that is not specified as a benefit or a liability in the contract

Question 6

What is marginal private cost?

Answer 6

The marginal cost to the decision maker

Question 7

What is marginal external cost?

Answer 7

Costs imposed on society by the decision maker

Question 8

What is marginal social cost?

Answer 8

The full cost of society

marginal private cost + marginal external cost

Question 9

What is caused by the marginal social cost being higher than the marginal private cost?

Answer 9

A negative external effect

Question 10

What is one solution to market failure, and what does it entail?

Answer 10

Bargaining: it involves legally assigning the property rights to the externality

Question 11

What does private bargaining lead to?

Answer 11

A Pareto-efficient allocation, regardless of the property rights, but only in a sense of transaction costs

Question 12

Which is more effective: private bargaining or government intervention?

Answer 12

Private bargaining can be more effective, but transaction costs can present a major issue

Question 13

What are the four practical limits of bargaining?

Answer 13

Impediments to collective action
Missing information
Enforcement
Limited funds

Question 14

Aside from bargaining, what is an alternative solution to market failure?

Answer 14

Government policies

Question 15

What are the three types of policies that can be enacted by governing bodies to stop market failure?

Answer 15

Regulation of product
Pigouvian tax/subsidy
Enforcing compensation for affected parties

Question 16

What are the practical limits of governments enacting policies?

Answer 16

Missing information
Measurement
Lobbying

Question 17

What are non-rival goods?

Answer 17

A good is non-rival if use by one person does not reduce its availability to others

Question 18

What are non-excludable goods?

Answer 18

Goods are non-excludable when they are free, as there is no way to exclude someone who hasn’t paid for it

Question 19

In terms of rival and excludable, what are private goods?

Answer 19

Always non-rival

Either excludable or non-excludable

Question 20

What goods to markets typically allocate?

Answer 20

Private goods

Question 21

When are markets unable to fail?

Answer 21

When allocating non-private goods

Question 22

What is asymmetric information?

Answer 22

When one party in a transaction knows something relevant, but the other party does not know this information

Question 23

What are the two forms of asymmetric information?

Answer 23

Hidden action

Hidden attributes

Question 24

What is hidden action and what does it lead to?

Answer 24

When one party in a transaction is hiding their actions (such as a business owner not disclosing their effort when someone has invested in the business), and it leads to a moral hazard problem

Question 25

What is hidden attributes and what does it lead to?

Answer 25

When one party knows information about an item and the other does not (such as someone selling something they know is broken, but not telling the buyer), and it can lead to adverse selection problems