Micro 19 - Information failure. Flashcards
what is the theory of externalities?
That the market fails because individuals do not care about the costs or benefits to the third party. Because these third-parties are ignored by the market transaction, the socially optimum level of output in not reached or overconsumption occurs.
Why might there be market failure even when there are no externalities?
Individuals don’t have a full set of information to make a decision - external costs/benefits.
what are demerit goods?
goods that have negative externalities - bad for you.
what are goods that are under consumed due to information failure called?
Merit goods - such as education.
With these goods, marginal social benefits are greater than marginal private benefits.
In the case of demerit goods, consumption is:
Over consumed.
Diagram for market failure due to information failure:
what is asymetric information?
When one group has more information than the other in a transaction.
Why does the market fail for cigarettes if left to free market?
As cigarettes are a demerit good, lack of information about the costs cause it to be over consumed.
what are a few types of insurance?
LIfe insurance.
Car insurance.
House insurance.
define moral hazard?
A situation in which a person takes more risk because they have insurance.
what is the problem with asymmetric information in the insurance market?
Individuals may have more information than the insurance company. This explains why there is a lack of formal insurance in the market. Theoretically, poor people should be be keen to take out insurance as they are more likely to get sick and cant afford the damage. In reality, people who have insurance are likely to change their behaviour by being more reckless and taking more risk.
why is moral hazard a problem?
Becaseu the insurance company has to pay out.
How do insurance companies tackle moral hazard?
They charge an excess.
what does an insurance company do to correct the problem of adverse selection?
Increase the premium.
Why is it a problem when insurance companies increase the premium for everyone if they can’t figure out who needs insurance now?
people who don’t need insurance, will not get insurance.
