Market Failures: Externalities

Question 1

What kinds of Market transaction costs exist?

Answer 1

Costs of search and information
Costs of bargaining and making a deal
Costs of control and enforcement
Investment to contacts

Question 2

What can the government do about these transaction costs?

Answer 2

↓ the costs of searching
Databases (e.g. in the labour market)

↓ the costs of bargaining
Supporting civil organizations

↓ the costs of making and enforcing contracts
Setting up and maintaining the legal framework
Providing law enforcement

Question 3

Explain negative externality according to the welfare loss

Answer 3

Marginal social cost> Marginal private costs–> This causes overproduction(the market is producing way over the social equilibrium)

Question 4

Explain positive externality using welfare gain/loss?

Answer 4

Social benefit>private benefit–> Which means the market is under consuming

Question 5

Sometimes when transaction costs are high, government intervention might be necessary. Explain the market-based type of govt.interventions and non-market ones.

Answer 5

Market-based type of govt. interventions:
-Corrective (Pigouvian) taxes or fines can be levied in order to raise the marginal private cost equal to the marginal social cost ( Assigning the proper tax requires a consideration of the increasing cost of pollution control/minimizing – govt. must set the correct “price” of pollution
-Subsidies/fines: setting marginal social benefits from pollution abatement equal to MC
-marketable permits (for pollution)under a cap and trade system.
(Here the government must set the desirable quantity of pollution)
Non-market type govt. interventions:
-Direct regulation, either of allowable production processes (inputs) or of allowable emissions levels (outputs) – also e.g. smoking regulations
-The choice among forms of regulation will be influenced by the relative importance of information requirements, transactions costs, and vulnerability to political manipulation