Unit 5 Flashcards
Positive Externality
Underproduction of output and therefore under-allocation of resources
Negative Externality
Overproduction of output and therefore overallocation of resources
Ways to correct negative externality
1) Private bargaining
2) Liability rules and lawsuits
3) Tax on producers
4) Direct controls
5) Market for externality rights
Ways to correct positive externality
1) Private bargaining
2) Subsidy to consumers
3) Subsidy to producers
4) Government provision
Moral Hazard Problem
the tendency of one party to a contract or agreement to alter his or her behavior
Adverse selection
One person knows something that the other does not
Assymetric information
Buyers and sellers do not have the same information
The study of market failures helps us
understand how regulating markets may help with the allocation of resources
study of government failure may help us to
understand how changes in the way the government functions may help to operate more efficiently
Demand-side market failures
demand curves do not reflect consumers full willingness to pay
Supply-side market failures
Supply curves do not reflect full cost of production
Allocation efficiency
mb=mc
Total surplus is at a maximum
Maximum willingness to pay=minimum acceptable price
Private goods
Cars, clothes, computers, etc.
- Rivalry-when one person buys and consumes a product it is no longer available for another person
- Excludability- sellers can keep people who do not pay for a service from obtaining the benefits
Public goods
Nonrivalry and nonexcludability
-leeds to a free rider problem- once a producer has provided a public good, everyone obtains the benefit
The more free riding the
less the demand
Cost benefit analysis
Comparison of mb and mc to figure out whether or not to provide or how much to provide of a service
Quasi-public good
exclusion is possible ie. education, streets, libraries etc.
(provided by the government through taxes)
Demand or MB for a public good is found by
vertically adding prices that all members of society are willing to pay for the last unit of output
Direct control
limit activity—raise MC of production
Coase Theorem
Individuals can negotiate their own mutually agreeable solutions to externality problems through private bargaining
(the fable of bees)
Subsidies
taxes in reverse
Provision
give free to all ie. flue shots
Optimal reduction of an externality
mb=mc
Public choice theory
economic analysis of government decision making, politics, and elections
Taxes should be
Simple, efficient, certain and fair
Benefits received principle
those who pay get the benefits
ie. if you have kids you pay for public schools
Ability to pay principle
more money=more taxes
Progressive taxes
Follows the ability to pay
higher income=higher tax rate
-federal income taxes are progressive
Proportional taxes
Flat tax, everyone pays the same RATE
-corporate taxes tend to be proportional
Regressive taxes
Tax rates increase as your income decreases
“everyone pays $100”
When a supplier is taxed, who pays?
Producers and consumers each pay half
The market system fails to produce public goods because
private firms cannot restrict the benefits of such goods only to consumers who are willing to pay for them
What are the economic functions of government
enforcing laws and contracts, providing public goods, correcting market failures
In a market economy, the distribution of income is
primarily determined by the prices of scarce resources people own
if the production of a good creates positive externalities, the private market will produce
too little of the good at too low a price
If the production of a good creates negative externalities, the private market will produce
too much of the good at too low a price
public choice theory is based on the idea that
self interest motivates participants in both the public and private sectors of the economy
You cannot expect the gvnmt to fix anything
Federal income tax is based on
ability to pay
Excise tax on gasoline is based on
benefits received
Sales tax is
regressive
An excise tax will generate the most revenue for government if
demand is inelastic
Moral hazard problem
after getting insurance, people act more recklessly
Adverse selection
people who actually need insurance will get it
