Market imperfections: Externalities, public goods and asymmetric information Flashcards
What do taxes generate for governments?
Revenue, which can then be spent in line with their budgets
What are externalities?
When an action affects third parties/ consequences without being reflected in a competitive price
What are positive externalities?
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
What are negative externalities
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
What are welfare impacts?
Externalities cause DWL as competitive equilibrium deviates from socially optimal levels
What are solutions to market failures?
- Government control (Bans)
- Pigouvian approach (tax per unit)
- Coasian approach (negotiations)
- Cap and trade (Quanity caps)
What are Government controls?
Direct regulations
e.g quotas, standards, bans
What is the Pigouvian approach for externalities?
Tax per unit. Tax/ subsides to alin with private incentives with social costs/ benefits
e.g carbon tax reduces emissions but increase prices
What is a negative of the Pigouvian approach?
Hard to measure and regulate
Unintended consequences as can ham industries
What are the positives of the Pigouvian approach?
Flexible
Revenue generating for gov
What is the coasian approach?
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
Positives of the Coasian approach?
Avoids gov intervention
Cheaper and more accepted ( no top down change)
Specific to situation
Negatives of the Coasian approach?
Hard when large parties are involved e.g climate change
Unequal information access
What is the Cap and trade approach?
Quantity, caps usage. Sets pollution quotas and permits trading to achieve efficient allocations
Advantages of the cap and trade approach
Flexible
Disadvantage of the cap and trade approach
Equity concerns as firms can buy their way out of permits
What are public goods?
Non-rival goods (consumed by many) and non-excludable (can’t prevent access)
What are the 3 types of public goods?
- pure public goods
- club goods
- commons
What are pure public goods?
Non rival and non excludable
e.g national defence, public radio and air quality
What are club goods?
Non - rival but excludable
e.g cable tv, private golf course, streaming services
What are commons?
Non excludable but rival when congested (Fisheries, forests, public parks)
Challenges that public goods can face
- Under-provision due to free riding
- Overuse of congestible goods
What is free-riding?
somone whos wants others to pay for public good but intended on using themselves
Non-excludable
Underprovisional risk
e.g public parks, vaccines
Solutions for public goods?
Government provisions via tax
Access regulations (Pigouvarian fees for congestible resources)
What is Asymmetric information?
When 1 party has more info than others in a transaction
Problems of asymmetric information?
Adverse selection
Moral hazard
What is adverse selection?
Hidden attributes that lead to market ineficenices or failures
e.g Insurance markets
What is moral hazard
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
Solutions to Asymmetric information
Screening (questions)
Signalling
Warranties
Incentives, compatible mechanisms to encourage truth telling and efficient behaviour
