unit 10

Question 1

examples of market failure

Answer 1

• over production of demerit goods - negative externalities
• monopolistic competition
• underproduction of merit goods - posative externalities
• not enough public goods
• high income inequality
• pollution / environmental concerns

Question 2

what is marginal private cost

Answer 2

Marginal cost borne by the producer:
in the absence of externalities, this is just the marginal cost (MC)

Question 3

what is marginal extenral cost

Answer 3

Marginal external cost (MEC) = the cost experienced by a third party
when an additional unit of output is produced.

Question 4

what is marginal social cost

Answer 4

Marginal social cost (MSC) = Marginal private cost + Marginal
external cost

Question 5

what makes a level of production and consumption Pareto efficient

Answer 5

is and only if the MSC = MSB

Question 6

effects of rights to achieve Pareto efficiency

Answer 6

The government can give one party property rights and let both parties reach a private agreement.

If the fishermen have the right to clean water, the plantation owners must compensate the fishermen for each ton of bananas produced.

If the plantation owners have the right to use pesticide, the fishermen will need to compensate the plantation owners for lost profits if they are to convince them to reduce banana production.

Question 7

4 obstacles to private bargaining

Answer 7

Impediments to collective action - There may be many parties on each side of the external effect

Missing or asymmetric information - Need to measure the costs of and benefits of everyone involved

Tradeability and enforcement - The legal system must be able to obtain the relevant information if
any individual reneges

Limited funds - Parties wishing to purchase a property right must have the funds

Question 8

3 ways a government can intervene

Answer 8

• regulation of the quantity of bananas produced
• taxation of the production or sale of bananas
• enforcing compensation of the fishermen for the costs imposed on them

Question 9

effects of regulation

Answer 9

reduce the costs of pollution for the fishermen

lower the plantations’ profits

Question 10

effects of taxation

Answer 10

• reduces the cost of pollution for the fishermen
• lowers plantations profits is greater as quantity is reduced and they have to pay tax

Question 11

effects of compensation

Answer 11

• reduces the cost of pollution for the fishermen and they gain payments
• effects on plantations is the same as tax

Question 12

how much compensation will be required for each ton of banans

Answer 12

the difference between MSC and MPC

Question 13

what are external benefits

Answer 13

when decisions have posative externalities: the social benefit is higher than the private benefit or MPC is higher than MSC

e.g. those who are vaccinated

Question 14

3 points about public goods

Answer 14

Public goods are cases where, if one individual incurs a cost to provide the good, many others can benefit too

In general: private costs of producing public goods are high compared to the private benefits, so that no individual has an incentive to provide the good

Public goods are non-rival: is available to one person it can be available to others at no additional cost

Question 15

3 points on excludable public goods

Answer 15

We describe non-rival goods for which exclusion is feasible as excludable public goods.

Examples of excludable public goods are the information in a copyrighted book, or a film shown in an uncrowded cinema.

Excludable public goods are sometimes called artificially scarce, or club goods.

Question 16

what are goods

Answer 16

‘Goods’: things that people want to use or consume.

Question 17

what are bads

Answer 17

‘Bads’: things that people don’t want, and might be willing to pay to not have

Question 18

what are Open access environmental resources:

Answer 18

they have features in common with public goods.

they used to be non-rival but have more recently been damaged or depleted by human activity.

Question 19

what is common land

Answer 19

Common land: resource shared by a specific community of users. ‘Tragedy of the commons’ describe cases in which open access leads to overexploitation of
resources

Question 20

how to allocate non rival goods efficiently

Answer 20

When goods are non-rival, the marginal cost is zero: Setting a price equal to marginal cost will not be possible unless the provider is subsidized.

If non-rival goods are also excludable, market provision may be possible, although the allocation is unlikely to be Pareto efficient.

When goods or resources are not excludable, there is no way to charge a price for them: Produced goods will not be privately provided, and resources will be overused.

Question 21

why should markets not provide everything (4)

Answer 21

Repugnant markets: creating a market for certain goods/services
would violate ethical/social norms e.g. slavery
* Other institutions may be more effective e.g. governments,
families
* Market mechanisms may crowd out norms of social preferences
* Merit goods: goods that should be available to everyone,
independently of their ability to pay e.g. education