PS 408 Midterm Final notecards Flashcards
What is market failure?
The economic situation defined by an inefficient allocation of goods and services in the free market
Why doesn’t the market allocate the particular good efficiently? Hint 4 reasons
Public goods
Externalities
Natural monopolies
Information asymmetries
What are the rationales for government intervention? Hint four
Public goods: will not be provided by market because private providers cannot exclude people who do not pay for public goods.
Externality: a situation in which by-product of either production or consumption of good may benefit or harm other people.
Natural monopoly: a situation in which one firm can produce the total output of the market at lower cost than several firms could.
Information asymmetry: occurs when one party to an economic transaction has greater knowledge or information than the other party.
What are the characteristics of Public Goods?
Non-exclusion: No individuals can be excluded from the benefits of the good. If a good lacks exclusion, no one can be prevented from consuming it. A market failure may occur when nonpayers over-exploit the good, imposing negative externality on other people.
Non-rivalry: The benefits of a good can be consumed by any individual without diminishing others benefits.
If a good lacks rivalry, the marginal cost of providing the good to one more person is zero. A market failure occurs if a provider charges a positive price.
How do the characteristics of public goods result in a market failure?
Due to non-excludability, it is difficult to charge individuals for the use of public good.
Free-rider problem: When individuals get the benefit from public goods without paying for their use because they do not report their true demand for the public goods.
Table of Public goods characteristics continued
Give an example of something that is excludable and non-rivalrous:
Give an example of something that is rivalrous and non-excludable:
Give an example of something that is excludable and non-rivalrous:
Give an example of something that is non-excludable and non-rivalrous:
Give an example of something that is excludable and non-rivalrous:
Shoes, clothing, and phones.
Give an example of something that is rivalrous and non-excludable:
A park, and the fishery. Problem, The tragedy of the commons arises when individuals or groups overuse the common-pool resource because they do not bear the full costs of their actions. A resource is overuse.
Give an example of something that is excludable and non-rivalrous:
Concert, tennis, club, and cable television.
Give an example of something that is non-excludable and non-rivalrous:
National defense, and a street lamp
What are the 4 sources of government failure? and example of each one
Direct democracy
e.g., paradox of voting, bundling
Representative government
e.g., rent seeking, electoral cycles
Bureaucratic supply
e.g., agency loss, bureau failure
Decentralized government
e.g., diffuse authority, fiscal externalities
What is the paradox of voting, rent-seeking, principal-agent problem, bureaucratic failure, and Geographic representation?
Paradox voting: brings into question the common interpretation of voting outcome as, “will of the people.”
Rent seeking: occurs when entity seeks to gain the existing wealth without increasing productivity (lobby).
Principal-agent problem: arises when there is a conflict of interest between the agent (bureaucrats) and the principal (politicians).
Bureaucratic failure is caused by
“Information asymmetry” between principals and agents
Limited competition makes bureaus “natural monopolies.”
Geographic representation is when politicians may adopt policies with visible “net benefits” to their own districts but large social costs, districts interests override those of the national one.
What does voting with one’s feet mean?
express one’s preferences through moving to better areas that provide optimal bundle of taxes and public goods. Better school district, cheaper property tax rate, etc.
What are fiscal externalities?
Fiscal externalities: Local jurisdictions have an incentive to try to exclude people who have below-average property values (little contribution to revenue), while trying to attract wealthier residents and industry.
It results in inequitable distribution of local public goods.
e.g., public education funding.
What is passive government failure? Examples?
Government does not diagnose market failures correctly. Some examples include monopolies, externalities, and information asymmetry.
What are the four ways of framing public policy problems and one example of each?
Tuition policy
→ pricing policy
Airplane noise
→ externality
Utility
→ Natural monopoly
Research
→ public goods
What are the 5 ways of supplying goods through nonmarket mechanisms and examples?
Direct supply: Government bureaus
Independent agencies: Government corporations, Special districts
Contracting out: Direct contracting, Indirect contracting
Providing insurance: Mandatory insurance, Subsidized insurance
Providing cushions: Stockpiling, Transitional assistance, Cash grants
What is the rationale for government corporations?
Single market failure test:
Natural monopoly
Other market failures (e.g., externalities, public goods)
What characteristics define a natural monopoly market?
High fixed costs (e.g., rail track, water, gas, electricity)
Potential for economies of scale (Average cost = Total cost/ quantity)
Rational for one firm to supply the whole market
High barriers to entry
Limited competition
Competition leads to a wasteful duplication of resources and non-exploitation of full economies of scale → allocative (or productive) inefficiency
What are the advantages and disadvantages of special districts?
Advantages
* Allow consumers to observe the
relationship btw service
provision and tax-price clearly.
* Internalize externalities that spill
across the boundaries of local
governments.
Disadvantages
* The costs that consumers face in
monitoring “mini-governments”
for different services.
Illinois is an example state which has many special districts
How to conduct/steps for benefit analysis?
Step 1: Identifying relevant impacts of the policy
Step 2: Assign a monetary value to each item
Step 3: Estimate costs and benefits by discounting for time and risk
Step 4: Selecting among policies, comparing costs and benefits
What is Geographic extent & Fiscal externality?
The intergovernmental grants transfer wealth or rents across the boundaries of local jurisdictions.
What is opportunity cost?
The implicit value of what you have to give up in order to choose something else.
The value of the next best alternative.
How can we measure opportunity cost?
It depends on the nature of the market.
What is an example of discounting for time and risk?
Present value: provides the basis for comparing costs and benefits that accrue at different times.
Expected value: provides the approach to deal with risky situations.
What is the value of 1,000 dollars in 1 year, 2 years, 3 years, and 10 years with a discount rate of 5%?
- 1000 × (1 + 0.05) = 1050, formula for 1 year
- 1050 × (1.05) = 1102.5, formula for 2 years
- 1000 ×(1.05)^3 = 1157.625, formula for 3 years
- 1000 ×(1.05) ^10 = 1628.9, formula for 10 years
- Identify a set of mutually exclusive contingencies
* One or more major floods in the next 20 years
* No floods in the next 20 years - Estimate the present value of net benefits under each contingency.
* $25 million if one or more floods
* - $5 million if no floods.
Assign a probability of occurrence to each contingency
1) P of major floods occurring:
* 0.02 2) P of no floods: 3) P of major floods occurring in the next 20 years: 4) P of no floods occurring in the next 20 years:
2) P of no floods:
* 1– 0.02 = 0.98
3) P of major floods occurring in the next 20 years:
* 1 - 0.98^20 = 0.33
4) P of no floods occurring in the next 20 years:
* 1 – 0.33 = 0.67
What project does offer the largest net benefits? need to look at the table
- Project B offers the largest net benefits.
