Section9 Flashcards
What are externalities?
- Externality: Cost or benefit of one person’s decision on a third party not considered by the decision-maker.
- Negative: Water/air pollution.
- Positive: Education, historic buildings.
- Externalities cause inefficiency in markets.
Externalities (negative or positive) cause markets to be inefficient, and thus fail to maximize total surplus
What is a negative externality?
- Negative Externality: Cost imposed on a third party.
- Socially optimal output is less than market equilibrium quantity.
- Example: Air pollution from cars.
What is a positive externality?
- Positive Externality: Benefit to a third party without payment.
- Market produces less than socially desirable quantity.
- Example: Vaccinations, basic research.
The market produces a smaller
quantity than what is socially
desirable.
The social value of the good
exceeds the private value of the
good.
How can governments address externalities?
- Taxes: Reduce negative externalities (e.g., Pigovian taxes). -> erhöht supply fct. -> true social cost
- Subsidies: Internalize positive externalities. -> erhöht demand fct. -> true social value
- Regulations: Set limits or standards (e.g., emission caps).
What is asymmetric information?
- One party knows more than the other (e.g., product quality).
- Leads to adverse selection (e.g., market for lemons).
- Creates inefficiency and market failure.
What is moral hazard?
- Behaviour changes after insurance or protection.
- Example: Reckless driving with car insurance.
- Mitigated by deductibles and policy conditions.
What is the Gini coefficient?
- Measures income inequality.
- 0 = perfect equality, 1 = all income by one household.
- Tool to assess societal inequality.
What are merit goods?
- Goods and services which can be provided by the market but may
be under-consumed as a result of imperfect information about the private as well as the social benefits at the time of consumption. -> provides pos. externality - Example: Education, healthcare (vaccination), postal services.
- Public sector support ensures equitable access.
Merit goods are offered by or with the support of the public sector because their consumption is assumed to be desirable by society.
In this case, the choice of public intervention is affected by equity and efficiency reasons.
What are bounded rationality and willpower?
- Bounded Rationality: Limited decision-making due to complexity.
- Bounded Willpower: Preference for short-term rewards (e.g., over-eating).
What is carbon pricing?
- Carbon taxes: Price per ton of emissions to reduce pollution.
-
Emissions trading systems (ETS): create a cap on total emissions and allow
companies to buy and sell allowances, creating an economic incentive to reduce
emissions.
Both tools aim to internalize the social cost of pollution into the market, aligning
economic activity with climate goals.
State Intervention: Environmental and Energy Policy Instruments
Traditional regulation instruments (‘command & control’)
-> Emission limits, technology standards
Economic instruments (market-based-policies)
-> Environmental taxes (e.g. pollution charges), targeted subsidies, etc.
Imperfect Competition
In order to ensure that the mechanism of the invisible hand works perfectly, the economic system must have a high level of competition.
In monopolistic markets: no competition
In oligopolistic markets: no competition
Whenever monopolistic or oligopolistic markets are present, the resource
allocation provided by the market may be inefficient because of:
Higher prices
Lower quantities
Imperfect Competition: State Intervention
Oligopoly: establishment of a competition authority
Monopoly: establishment of a regulatory authority
Adverse Selection
- Adverse selection occurs when individuals with higher risks are more likely to seek insurance. Insurers, unable to perfectly differentiate between high-risk and low-risk individuals, may end up with a disproportionately risky pool of insureds. For instance, people with chronic health issues are more likely to purchase comprehensive health insurance.
- Consequences of adverse selection can include higher premiums for all policyholders, or even a “death spiral” where only the highest-risk individuals
remain in the pool, leading to unsustainably high premiums and market failure.
A non-waivable amount
A non-waivable amount refers to a sum of money that cannot be reduced, forgiven, or negotiated away, regardless of agreements between parties. It is often used in legal, financial, or contractual contexts where certain fees, costs, or penalties must be paid no matter what.
For example:
* Legal fines and penalties
Too big to fail
Too big to fail situations: belief that certain firms/financial institutions are so
large, interconnected, or vital to the economy that their failure would have disastrous effects on the entire financial system.
These institutions are often viewed as too necessary to be allowed to collapse because their downfall could lead to systemic crises, such as widespread
unemployment, significant declines in economic activity, or severe market disruptions.
Moral hazard: both managers and investors may assume that the government will prevent the company from going bankrupt, even if it makes poor decisions or takes excessive risks engage in high-risk activities, believing they will be bailed out in a crisis
Sectors: financial sector, electricity sector
State Intervention: too big to fail and moral hazard
Possible solutions to correct the market failure determined by asymmetric
information:
Introduction of regulations that force sellers to provide information on goods
and services sold
Oblige sellers to offer warranties or guarantees on items sold
Information campaigns to inform consumers of products and sellers’ quality
and reputation
Income and Wealth Inequalities
Competitive markets may result in:
Individual wealth and income inequality
Regional wealth and income inequality
High individual and regional wealth and income inequalities may not be accepted
by the society -> market failure
State Intervention: Social Policy Instruments
Social policy instruments: taxation system, subsidies, merit goods,…
Normally, the redistribution of income and wealth is not supported by
arguments of economic efficiency but by major social values, equity values.
The decisions related to the redistribution of income are normative and
accordingly, they need a political decision.
Example Income Taxation: Progressive Marginal Tax Rate
Example Subsidy: Subsidy to Pay Health Insurance Premiums
Public Services Are Considered Merit Goods: a Definition That Can Change Over Time
Reasons:
Technological progress
Change of citizen-consumers’ preferences
Change in the values of a society (e.g. importance given to equity and efficiency, to redistributive policies, to solidarity
between urban and rural and peripheral regions)
With the development of mobile phone, telephone boxes are no longer considered a Public service
