Section 5: Market Failures

Question 1

Define market failure

Answer 1

When an assumption of supply and demand doesn’t hold

Question 2

Define externality

Answer 2

A transaction between a buyer and seller that affects a third party and the third party’s preference is not expressed in the transaction. The free market outcome is inefficient

Question 3

Explain what a negative externality is and provide examples

Answer 3

Producing or consuming activity causes a cost for a third party. Examples include pollution from production, congestion from driving, fishing depletes stocks.

Question 4

Explain what a positive externality is and provide examples

Answer 4

Producing or consuming activity provides a benefit to a third party. Examples include clean air, bee-keeping, research and development, immunization, good home maintenance and high neighbouring property values

Question 5

Name the 2 methods to internalize an externality

Answer 5

1. Put a price on it with a Pigouvian tax

2. Assign property rights with Coase theorem

Question 6

What are some drawbacks of a Pigouvian tax?

Answer 6

1. Challenges to monetize the externality
2. Weak sustainability
3. Low political acceptability
4. Equity impacts

Question 7

Under the classes of goods, common property resources are…

Answer 7

Non-excludable and rivalrous

Question 8

Under the classes of goods, public goods are…

Answer 8

Non-excludable and non-rivalrous

Question 9

Under the classes of goods, private goods are…

Answer 9

Excludable and rivalrous

Question 10

Under the classes of goods, club goods are…

Answer 10

Excludable and non-rivalrous

Question 11

What type of externality do public goods produce?

Answer 11

Positive

Question 12

What type of externality do common pool resources produce?

Answer 12

Negative

Question 13

For public goods, the market demand curve is the ___ sum of individual demand curves

Answer 13

Vertical

Note that other demand curves are the horizontal sum