Market Failure & Policy (1)

Question 1

What is the difference between “equity” and “efficiency”?

Answer 1

Equity considers how resources are distributed throughout society

Efficiency is concerned with optimal production and allocation of resources given the available factors of production

Question 2

Give 5 assumptions for market equilibrium in a perfectly competitive market

Answer 2

• Perfect competition
• Under perf comp, market equil is Pareto optimal
• Total surplus is maximised and achieves socially optimal quantities
• Existence of the “invisible hand” (competitive markets naturally being channelled towards social efficiency)
• “Laissez-faire” (no government interference)

Question 3

Give 4 situations which depart from these assumptions i.e. 4 sources of market failure

Answer 3

• Imperfect competition
• Imperfect information
• Public goods
• Externalities

Question 4

What 2 characteristics can be used to distinguish different types of good?

Answer 4

Rivalry - consumption of one at the expense of another

Excludability - Prevention of certain agents from consuming the good

Question 5

Name 4 types of good and their corresponding characteristics

Answer 5

Pure private - rivalry and excludability

Pure public - neither rivalry nor excludability

Open access - Rivalry but no excludability

Congestible - Excludability but no rivalry up to the point where congestion occurs (rivalry after this point)

Question 6

What is the free-rider problem?

3 points

Answer 6

Occurs in public goods, when only one agent invests in a public good, allowing other agent(s) to benefit from the good without paying for it

This is not socially optimal

Hence causes a DWL

Question 7

Draw a diagram to model 2 agents (one with a higher MB than the other) and a public good

Answer 7

[See Diagram 1 on your diagrams sheet]

Question 8

Why is there no incentive for markets to supply public goods?

What can supply public goods and why?

Answer 8

Because there’s no point in a firm producing something that everyone can consume for free

Government can supply them because it can force people to pay taxes

Question 9

What is “the preference revelation problem”?

Answer 9

A way of ascertaining public demand for public goods using game theory (see your notes for the appropriate table)

Question 10

When do externalities arise?

2 separate points

Answer 10

When the private costs of production/consumption are not equal to the social costs of production/consumption

Said to occur when the prodn/consmn decisions of one agent have an impact on the utility/progit of another in an unintended way, and no compensation is provided by/awarded to the generator of the impact to/from the affected party

Question 11

What are the 2 types of externalities (other than +ive and -ive)?

(explain)

Answer 11

Production externalities - exerted by a firm in the process of production

Consumption externalities - generated by the consumption process of an individual

Question 12

Draw diagrams to illustrate positive and negative externalities

Answer 12

[See number 2 on your diagrams sheet]

Question 13

Explain the deadweight loss associated with positive externalities

Answer 13

The societal benefit gained from the good is higher than the private consumers benefit of the good, so their is an extra societal benefit that is foregone if the quantity if not increased

Question 14

Explain the deadweight loss associated with negative externalities

Answer 14

Marginal private costs associated with consuming/producing the good are lower for the private agent than they are for society as a whole. Hence the amount that is consumed/produced is higher than the social optimum

Question 15

Give 3 reasons why externalities might arise

Answer 15

• If property rights are not clearly defined
• If there are transaction costs (i.e. the bargaining process is very expensive)
• Free-riding (when some agents can free-ride on the effort made by other agents who pay a firm to stop polluting

Question 16

What is stated by the Coase Theorem?

Answer 16

In an externality situation caused by incomplete private property rights, one solution involves creating property rights for either the victim or the generater, and either assignment will lead to an efficient (not necessarity equitable) outcome

Question 17

What are the 2 classes of pollution?

Give the denotation of each

Answer 17

Flow-damage pollution D(M)

Stock-damage pollution D(A)

Question 18

Why does flow-damage pollution occur?

Elaborate

(2 points)

Answer 18

Occurs because of the rate at which the pollutant is emitted

The level of damage goes to zero as soon as the flow of emissions stops

Question 19

Outline stock-damage pollution

Answer 19

The damage depends on the stock of the pollutant in the environmental system at any point in time

Damage still there even when the pollutant is not being produced

Question 20

Denote the damage, benefit and net benefit of flow pollution

Answer 20

D = D(M)

B = B(M)

NB = B(M) - D(M)

Question 21

What are the 2 types of stock pollutant?

Answer 21

Uniformly mixing

Non-uniformly mixing

Question 22

What is a uniformly mixing pollutant?

2 points

Answer 22

A pollutant that, when emitted by one individual, mixes with the pollutants of others

Becomes dispersed to the point where spatial distribution is uniform

Question 23

What is a non-uniformly mixing pollutant?

1 point

Answer 23

A pollutant that has localised effects

Question 24

For a uniformly mixing pollutant, what is the relationship between the stock size and level of emissions?

Answer 24

A = kM

where A = stock size k = constant growth rate over time M = level of emissions

Question 25

What is the intertemporal stock equation (i.e. growth rate of the stock) for a uniformly mixing pollutant?

Answer 25

Ȧt = dA/dt = Mt – δAt

Deterioration δ occurs due to chemical/biological processes

Example: CO2

Question 26

For which type of stock pollution does the location of the source of the emissions matter?

Answer 26

Non-uniformly mixing pollution

Question 27

For a non-uniformly mixing pollutant, what is the equation for the total level of pollution at location “j”?

Answer 27

Aj = ∑(i=1)^N dijMi

where j=location, N=no of emission sources, M=emissions measure, d=captures the impact of emissions at source (i) on the pollutant concentration at location (j)

Question 28

What are the potential problems associated with non-uniformly mixing pollutants?

(3 points)

Answer 28

• May be unethical for damage (A) to vary by location
• But inappropriate regulations may cause firm closure/job loss
• Hence there is a trade-off between health benefits/the environment and job loss

Question 29

What is “convexity”?

4 points

Answer 29

A condition which ensures that the equilibrium solution is unique

Ensures that the equilibria we obtain are optimal

I.e. there is only one point where the marginal benefit of pollution = the marginal damage

(we assume that damage function is convex; total benefit function is concave)

Question 30

Give a cause of non-convexities in a damage function

Give an example of where this occurs

Answer 30

Threshold effects (tipping points)

E.g. eutrophication in lakes - after a point, the lake becomes biologically dead, and the level of damage done is hence unaffected by the pollution level after this point

Question 31

Give 4 objectives of pollution policy

Answer 31

Economic efficiency

Sustainability / ecological goals

Public preferences

Question 32

What are the 4 types of policy instruments used for pollution control?

Answer 32

Institutional approaches

Command & control instruments

Pigouvian policies

Marketable emission permits

Question 33

Explain the institutional approach to pollution control

Answer 33

Internalises the externality e.g. firms are held liable if their pollution causes health effects

Question 34

What are command and control instruments?

3 points

Answer 34

A way of ensuring that a firm complies with standards

A restriction on technologies used

Dominant method of reducing pollution

Question 35

What are the potential problems with command and control instruments?

(2 points)

Answer 35

• Not cost efficient. They raise barriers to entry which can cause the market to become less competitive
• May reduce incentives for firms to invest in efficient abatement technologies

Question 36

What are Pigouvian policies?

Answer 36

Price mechanisms (e.g. taxes or standards) which equate marginal private costs with social costs

Question 37

What are marketable emission permits?

Answer 37

Transferable permits that allow firms to pollute up to a certain level