Market failure Flashcards
Formula for positive externality of consumption
MPB < MSB
Solutions to positive externalities of consumption
- subsidise firms
- direct govt provision
- positive advertisement
- legislation
Problems with subsidizing firms (for positive externalities of consumption)
- cost for govt (opportunity cost)
- production inefficiencies because part of the producer’s revenue is guaranteed by the govt
Problems with direct govt provision (for positive externalities of consumption)
- cost to govt (opportunity cost)
- bad quality of good or service (the govt might be less efficient than the private firms that provide it)
- private firms may be dissuaded from investing in the industry because the govt will provide for it anayway
problems with positive advertising (for positive externalities of consumption)
cost for govt might be high (opportunity cost)
problems with legislations (for positive externalities of consumption)
- will only be successful if the govt provides the good/service free of charge
- some people might see it as an infringement of their rights
- there is additional cost in enforcing the law
formula for positive externality of production
MSC < MPC
solutions to positive externalities of production
direct govt provision, subsidies
problems with direct govt provision (for positive externalities of production)
- opportunity cost for govt
- govt might lack expertise found in firms
- private firms may be dissuaded from investing in the industry
problems with subsidies
(as a method of correcting positive externalities of consumption)
- difficult for govt to estimate the level of subsidy each firm deserves
- opportunity cost for govt
formula for negative externality of consumption
MPB > MSB
solutions to negative externalities of consumption
- banning or regulating the good
- indirect tax
- negative advertisement (education)
problems with banning or regulating the good
(as a solution for negative externalities of consumption)
- negative effect on shareholders and unemployment
- effect of govt revenue because it stops receiving taxes from that industry
- negative reaction from consumers
- additional costs of enforcing the law
problems with indirect taxes (for negative externality of consumption)
- often taxed goods tend to be inelastic so consumption isn’t always decreased
- black markets might appear
problems with negative advertisement / education (for negative externality of consumption)
- opportunity cost for the govt
- doubts about effectiveness
formula for negative production externality
MSC > MPC
solutions for negative production externalities
- taxes
- legislations
- tradeable emission permits
problems with tradeable emission permits (for negative production externalities)
- difficult to determine an acceptable level of pollution
- difficult to measure a firm’s pollution
- pollution is still present
problems with legislations/regulations
(as a method of correcting negative production externalities)
- unemployment
- creates non-consumption of the good (though the good might be necessary for producers)
- high cost in setting and enforcing the legislation
problems with taxes
(as a method of correcting negative production externalities)
- difficult to set a value on the externality
- difficult to identify which firms are responsible for what levels of production
- don’t actually stop the pollution from taking place
characteristics of common pool resources
Rivalrous and non-excludable.
This means that the consumption of the good reduces its availability for others but it is impossible to exclude others from using it (i.e. finite but priced at 0)
how does unsustainable production of common pool resources create negative externalities?
The lack of price means that the rationing function does not occur, leading to overuse
solutions to the tragedy of the commons
- Carbon taxes
- Tradeable emission permits
- Subsidizing cleaner substitute gods
- Legislation
- Collective self-governance
characteristics of public goods
non-rivalrous and non-excludable.
This means that the consumption of the good does not reduce its availability for others and it is impossible to exclude others from using it.
what is the free rider problem?
When people can enjoy a good without paying for it, it creates market failure as there is no incentive that incentivizes firms to produce the good.
Forms of government intervention in response to public goods
- free govt. provision
- contracting out to the private sector
asymmetric information
definition + types
When buyers and sellers do not have equal access to information.
Types:
- Adverse selection: when one party (buyer or seller) has more information than the other party about the quality of the product being sold
- Moral hazard: where one party takes a risk but does not bear all of the consequences of the risk
government responses to adverse selection
- regulation
- provision of information
- licensure
private responses to adverse selection
- screening: consumers seek more information by screening (researching) the product
- signalling: the use of trusted measures of quality to signal the quality of the product (e.g. warratnies, brand names)
free good vs economic good
Public good:
- Is not scarce
- Has 0 opportunity cost
Economic good:
- Is scarce
- Has an opportunity cost
responses to moral hazard
Solutions seek to realign the incentives:
- insurance
- deductibles (out-of-pocket)
