Market imperfections: Externalities, public goods and asymmetric information

Question 1

What do taxes generate for governments?

Answer 1

Revenue, which can then be spent in line with their budgets

Question 2

What are externalities?

Answer 2

When an action affects third parties/ consequences without being reflected in a competitive price

Question 3

What are positive externalities?

Answer 3

A benefit received or transferred to a party as an indirect effect of the transactions of another party.

Positive externalities arise when one party, such as a business, makes another party better off but does not receive any compensation for doing so
e.g choosing to walk to work rather than drive

Question 4

What are negative externalities

Answer 4

The imposition of a cost on a party as an indirect effect of the actions of another party

Negative externalities arise when one party, such as a business, makes another party worse off, yet does not bear the costs from doing so
e.g smoking, driving under the influence

Question 5

What are welfare impacts?

Answer 5

Externalities cause DWL as competitive equilibrium deviates from socially optimal levels

Question 6

What are solutions to market failures?

Answer 6

1. Government control (Bans)
2. Pigouvian approach (tax per unit)
3. Coasian approach (negotiations)
4. Cap and trade (Quanity caps)

Question 7

What are Government controls?

Answer 7

Direct regulations
e.g quotas, standards, bans

Question 8

What is the Pigouvian approach for externalities?

Answer 8

Tax per unit. Tax/ subsides to alin with private incentives with social costs/ benefits
e.g carbon tax reduces emissions but increase prices

Question 9

What is a negative of the Pigouvian approach?

Answer 9

Hard to measure and regulate
Unintended consequences as can ham industries

Question 10

What are the positives of the Pigouvian approach?

Answer 10

Flexible
Revenue generating for gov

Question 11

What is the coasian approach?

Answer 11

Negotiations. Assigns property rights for externalities and allows negotiations/ trade
e.g factory emissions for those arround, either locals pay for company to reduce or compensation from factory
e.g water, land

Question 12

Positives of the Coasian approach?

Answer 12

Avoids gov intervention
Cheaper and more accepted ( no top down change)
Specific to situation

Question 13

Negatives of the Coasian approach?

Answer 13

Hard when large parties are involved e.g climate change
Unequal information access

Question 14

What is the Cap and trade approach?

Answer 14

Quantity, caps usage. Sets pollution quotas and permits trading to achieve efficient allocations

Question 15

Advantages of the cap and trade approach

Answer 15

Flexible

Question 16

Disadvantage of the cap and trade approach

Answer 16

Equity concerns as firms can buy their way out of permits

Question 17

What are public goods?

Answer 17

Non-rival goods (consumed by many) and non-excludable (can’t prevent access)

Question 18

What are the 3 types of public goods?

Answer 18

1. pure public goods
2. club goods
3. commons

Question 19

What are pure public goods?

Answer 19

Non rival and non excludable
e.g national defence, public radio and air quality

Question 20

What are club goods?

Answer 20

Non - rival but excludable
e.g cable tv, private golf course, streaming services

Question 21

What are commons?

Answer 21

Non excludable but rival when congested (Fisheries, forests, public parks)

Question 22

Challenges that public goods can face

Answer 22

1. Under-provision due to free riding
2. Overuse of congestible goods

Question 23

What is free-riding?

Answer 23

somone whos wants others to pay for public good but intended on using themselves
Non-excludable
Underprovisional risk
e.g public parks, vaccines

Question 24

Solutions for public goods?

Answer 24

Government provisions via tax
Access regulations (Pigouvarian fees for congestible resources)

Question 25

What is Asymmetric information?

Answer 25

When 1 party has more info than others in a transaction

Question 26

Problems of asymmetric information?

Answer 26

Adverse selection
Moral hazard

Question 27

What is adverse selection?

Answer 27

Hidden attributes that lead to market ineficenices or failures
e.g Insurance markets

Question 28

What is moral hazard

Answer 28

Hidden actions post - contract
e.g car innsurance - those with comprehensive may drive less cautious as will be paid for
Unemployment benefits - less likely to get a job

Question 29

Solutions to Asymmetric information

Answer 29

Screening (questions)
Signalling
Warranties
Incentives, compatible mechanisms to encourage truth telling and efficient behaviour