Market Failure & Policy (1) Flashcards
What is the difference between “equity” and “efficiency”?
Equity considers how resources are distributed throughout society
Efficiency is concerned with optimal production and allocation of resources given the available factors of production
Give 5 assumptions for market equilibrium in a perfectly competitive market
- 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)
Give 4 situations which depart from these assumptions i.e. 4 sources of market failure
- Imperfect competition
- Imperfect information
- Public goods
- Externalities
What 2 characteristics can be used to distinguish different types of good?
Rivalry - consumption of one at the expense of another
Excludability - Prevention of certain agents from consuming the good
Name 4 types of good and their corresponding characteristics
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)
What is the free-rider problem?
3 points
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
Draw a diagram to model 2 agents (one with a higher MB than the other) and a public good
[See Diagram 1 on your diagrams sheet]
Why is there no incentive for markets to supply public goods?
What can supply public goods and why?
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
What is “the preference revelation problem”?
A way of ascertaining public demand for public goods using game theory (see your notes for the appropriate table)
When do externalities arise?
2 separate points
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
What are the 2 types of externalities (other than +ive and -ive)?
(explain)
Production externalities - exerted by a firm in the process of production
Consumption externalities - generated by the consumption process of an individual
Draw diagrams to illustrate positive and negative externalities
[See number 2 on your diagrams sheet]
Explain the deadweight loss associated with positive externalities
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
Explain the deadweight loss associated with negative externalities
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
Give 3 reasons why externalities might arise
- 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
What is stated by the Coase Theorem?
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
What are the 2 classes of pollution?
Give the denotation of each
Flow-damage pollution D(M)
Stock-damage pollution D(A)
Why does flow-damage pollution occur?
Elaborate
(2 points)
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
Outline stock-damage pollution
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
Denote the damage, benefit and net benefit of flow pollution
D = D(M)
B = B(M)
NB = B(M) - D(M)
What are the 2 types of stock pollutant?
Uniformly mixing
Non-uniformly mixing
What is a uniformly mixing pollutant?
2 points
A pollutant that, when emitted by one individual, mixes with the pollutants of others
Becomes dispersed to the point where spatial distribution is uniform
What is a non-uniformly mixing pollutant?
1 point
A pollutant that has localised effects
For a uniformly mixing pollutant, what is the relationship between the stock size and level of emissions?
A = kM
where A = stock size k = constant growth rate over time M = level of emissions
What is the intertemporal stock equation (i.e. growth rate of the stock) for a uniformly mixing pollutant?
Ȧt = dA/dt = Mt – δAt
Deterioration δ occurs due to chemical/biological processes
Example: CO2
For which type of stock pollution does the location of the source of the emissions matter?
Non-uniformly mixing pollution
For a non-uniformly mixing pollutant, what is the equation for the total level of pollution at location “j”?
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)
What are the potential problems associated with non-uniformly mixing pollutants?
(3 points)
- 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
What is “convexity”?
4 points
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)
Give a cause of non-convexities in a damage function
Give an example of where this occurs
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
Give 4 objectives of pollution policy
Economic efficiency
Sustainability / ecological goals
Public preferences
What are the 4 types of policy instruments used for pollution control?
Institutional approaches
Command & control instruments
Pigouvian policies
Marketable emission permits
Explain the institutional approach to pollution control
Internalises the externality e.g. firms are held liable if their pollution causes health effects
What are command and control instruments?
3 points
A way of ensuring that a firm complies with standards
A restriction on technologies used
Dominant method of reducing pollution
What are the potential problems with command and control instruments?
(2 points)
- 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
What are Pigouvian policies?
Price mechanisms (e.g. taxes or standards) which equate marginal private costs with social costs
What are marketable emission permits?
Transferable permits that allow firms to pollute up to a certain level
