Unit 12 - Markets, Efficiency and Public Policy Flashcards
What conditions are required for a market to work well
Private property - The rights to the item bought/sold
Institutions - Governments enforce property rights
Social Norms - respecting property rights
Ability to write complete and enforceable contracts that can be evaluated in a court of law
What are the types of market failure
External effects - An effect of an economic decision that is not specified as a benefit or liability in the contract
Asymmetric information
Incomplete contracts
What are possible solutions to market failure
Private bargaining, government policies
What is:
Marginal Private Cost (MPC)
Marginal External Cost (MEC)
Marginal Social Cost (MSC)
MPC = marginal cost to decision-maker
MEC = cost imposed by decision-maker on society
MSC = MPC + MEC (full cost to society)
What is negative external effect
When MSC > MPC
What is a pareto efficient allocation when there are negative externalities
Price = MSC
Gap between MSC and MPC could be privately bargained (for a price between 0 and gap between MSC and MPC)
What is Coasean Bargaining
The idea of legally assigning rights to the externality (right to pollution/ right to clean water)
Allows for private bargaining and will result in pareto efficient allocation, in the absence of transaction costs
HOWEVER, transaction costs (costs of acquiring info, enforcing contract) can be a major obstacle in real life
More effective than Government intervention as private parties have more of the information
What are the practical limits of bargaining
Impediments to collective action - finding a representative and agreeing how to split gains with each party
Missing information - calculating the exact costs imposed on each fisherman and each plantation’s contribution to pollution
Enforcement - might be difficult for the court to determined whether parties have complied or not
Limited funds - (fisherman example) may not have enough money to pay compensation to plantations to reduce output
What Government policies can tackle negative external effects
Regulation of production - cap at socially optimal amounts; might be difficult to determine and enforce right quota for each polluter
Pigouvian tax - tax on firms generating negative external effects, in order to correct an inefficient market outcome.
- Pigouvian subsidy: a subsidy to firms generating positive external effects.
Enforcing compensation for affected parties.
What are practical limitations of policies
Missing information – government may not know the exact compensation needed to correct the problem
Measurement – Marginal social costs are difficult to measure
Lobbying - The government may favour the more powerful group, in which case it could impose a
Pareto-efficient outcome that is unfair
Why do external costs/benefits occur
Occur due to incomplete contacts. Contracts that do include external costs/benefits are not enforceable as the relevant info is not verifiable or assymetric
What is:
Rival/Non-rival
Excludable/Non-excludable
Rival = Use by one person reduces its availability for others
Excludable = Ability to exclude people from having access to the good
What is a Public good
A good that is Non-rival; may or may not be excludable
Why are markets not possible for goods that are not private (Rival & Excludable)
Non-rival goods are readily available so there is no marginal cost, therefore it is not possible to set P=MC
Cannot set a price for Non-excludable either as provider cannot exclude those that haven’t paid
What is Asymmetric information and what are the two types
When one party knows something relevant to the transaction that the other party does not
Types are:
Hidden actions - leads to moral hazard problem (Such as inability to monitor employee effort)
Hidden attributes - leads to an adverse selection problem (buyers of second hand cars do not know all attributes but sellers do)
