PS 408 Midterm Study Guide Flashcards
What is market failure?
market failure is the inefficiency of the allocation of goods and services, resulting in a suboptimal outcome.
What are the four reasons that market failure can occur?
1.) Externalities
2.) Public Goods
3.) Natural Monopolies
4.) Asymmetry
What are the characteristics of public goods? And give an example
1.) nonrivalrous: A good is nonrivalrous in consumption when more than one person can derive consumption benefits from some level of supply at the same time.
2.) non-excludability: A good is nonexcludable if it is impractical for one person to maintain exclusive control over its use. For example, species of fish that range widely in the ocean are usually nonexcludable in use because they move freely among regions such that no individual can effectively exclude others from harvesting them.
Examples of public goods: National defense or a street lamp
What are the characteristics of a natural monopoly?
Natural monopoly occurs when average cost declines over the relevant range of demand.
1.) Economies of scale: Natural monopolies can take advantage of economies of scale, which occur when the cost per unit decreases as the level of output increases.
2.) Barrier to entry: Because a natural monopoly can produce goods or services at a lower cost than any potential competitor, it can create a barrier to entry for other firms.
3.) High fixed costs: Natural monopolies often involve high fixed costs, such as large investments in infrastructure or specialized equipment.
4.) Price maker: As the sole producer in the market, a natural monopoly has the ability to act as a price maker, setting prices without fear of competition.
Examples of natural monopolies may include: water and electricity companies, and gas pipelines.
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 problems associated with public goods?
Free rider problem: A person who enjoys the benefit of a good but does not pay for it.
Pure public goods: will not be provided by market because private providers cannot exclude people who do not pay for public goods.
Tragedy of the commons: Some public goods, such as clean air and water, are also common-pool resources, meaning that they are non-excludable but rivalrous. Overuse or depletion of these resources can lead to the tragedy of the commons, where individuals or groups overuse the resource because they do not bear the full costs of their actions.
What are the characteristics of externalities?
- Externalities: a situation in which by-product of either production or consumption of good may benefit or harm other people.
- Negative externalities: externalities that harm others
- Air and water pollution generated by firms
- Cigarette smoke that nonsmokers must breathe in public places
- Positive externalities: externalities that benefit others
- Vaccinations
- Digital music exchange
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.
What is a government failure?
an economic inefficiency (inefficient allocation of
resources) caused by a government intervention or problems inherent
in political system.
What causes government failure?
- Direct democracy
- Representative government
- Bureaucratic supply
- Decentralized government
Why does direct democracy cause government failure?
Paradox of voting:
* Voting right is the foundation of democracy.
* Mechanism for aggregating individual preferences.
* In elections, voters select candidates whose policy positions most closely match their own policy position or preferences.
the paradox of voting is still present, as the probability of an individual’s vote affecting the outcome of a policy decision is similarly low. This can lead to government failure, where the policy outcome chosen does not reflect the preferences of the majority of the population.
Bundling: a process where several policy proposals are combined into a single package, and voters are given the option to vote for or against the package as a whole, rather than each policy proposal individually.
can create a situation where voters are forced to choose between supporting policies they may not agree with to achieve a desired outcome, or voting against the entire package, which may mean rejecting policies they support.
What is the problem of bundling?
Voters evaluate the bundle of positions offered by candidate.
* Different voters vote for the same candidate for different reasons.
e.g., support tax policy (tax cuts), but do not support immigration policy.
* A particular policy in bundle ≠ the will of a majority.
Why does a representative government cause government failure?
Rent seeking:
* Occurs when an entity seeks to gain the
existing wealth without increasing
productivity.
* Someone who try to get a larger slice of
the cake without an effort to make the
cake bigger.
* When a rent-seeker gains benefits,
someone else must lose those benefits. such as lobbying for favorable government policies, seeking monopoly privileges, or engaging in legal or regulatory actions that create barriers to entry for competitors.
Electoral cycles:
* Representatives should select policies for which benefits > costs.
* In reality, representatives select policies with visible net benefits to
increase the odds of being reelected.
* Electoral cycles interact with the partisan preferences of incumbents,
electoral cycles can cause government failure in a representative government if politicians prioritize short-term goals that will help them get re-elected over long-term policies that are in the public interest, leading to a misallocation of resources and suboptimal policy outcomes.
Influence of interest group
Geographic constituencies
Public attention.
What is geographic representation?
The problem of geographically defined districts.
* Self-interest (e.g., reelection) = districts’ interests ≠ national welfare.
* Politicians may adopt policies with “visible net benefits” to their own
districts for the short-term but large social costs in subsequent years.
* Politicians avoid political risks of raising taxes.
* Logrolling for district “pork” contributes to deficit spending.
Why does a bureaucratic supply cause government failure?
This is mainly because of the principal-agent problem: arises when there is a conflict of interest
between the agent (bureaucrats) and the principal (politicians).
* Asymmetric information: Agent often has more information than the
principal.
* Agents can pursue their own interests to some extent, taking
advantages of asymmetric information.
Agency loss
Limited competition
Why does decentralization cause government failure?
Bureau failure as market failure
Diffuse authority of Federalism
Fiscal externalities