Unit 12: Markets, Efficiency & Public Policy Flashcards
What is an externality?
An effect of an economic decision not included in the contract (external effect).
What does MSC = MPC + MEC mean?
Marginal Social Cost equals Marginal Private Cost plus Marginal External Cost.
When does a negative externality occur?
When MSC > MPC, leading to overproduction.
What is the Coase Theorem?
Private bargaining over externalities can lead to efficient outcomes if transaction costs are low.
What are limits to Coasean bargaining?
Transaction costs, missing information, enforcement difficulties, and collective action problems.
What is a Pigouvian tax?
A tax on a firm generating negative externalities to correct market failure.
What is a Pigouvian subsidy?
A subsidy to encourage firms that generate positive external effects.
Why are incomplete contracts a problem?
They fail to capture all social costs/benefits due to unverifiable or asymmetric information.
What is a public good?
A good that is non-rival and non-excludable.
Why do public goods cause market failure?
Because they are underprovided due to the free-rider problem.
What is asymmetric information?
When one party in a transaction has more relevant information than the other.
What is moral hazard?
When hidden actions lead to riskier behavior post-contract (e.g. careless driving after insurance).
What is adverse selection?
When hidden attributes cause only high-risk individuals to participate (e.g. sick people buying insurance).
What is an example of a missing market?
Healthy people not buying insurance due to high premiums caused by adverse selection.
How does the banking system exhibit moral hazard?
Banks take more risks expecting bailouts because of systemic importance.
What happens when P > MC?
There is inefficiency and deadweight loss due to market power or monopoly.
What is a natural monopoly?
A market where one firm can supply the good more efficiently than many due to economies of scale.
What are merit goods?
Goods that should be provided to everyone regardless of ability to pay, like education.
What are repugnant markets?
Markets that violate social norms or ethics (e.g. slavery).
What is the role of government in market failure?
To regulate, tax, subsidize, or compensate to correct inefficiencies.
Why might markets not allocate all goods efficiently?
Due to externalities, incomplete contracts, asymmetric info, and ethical limits.
