Week 4

Question 1

What are two reasons why efficient allocations fail?

Answer 1

1. policy/government
2. market failures

Question 2

What is efficient allocation?

Answer 2

Marginal cost = marginal WTP
maximizes the net benefit to society = total benefits - total cost

Question 3

What is a deadweight loss?

Answer 3

The net loss to society caused by inefficient allocation

Question 4

What does Q’ mean

Answer 4

producing BELOW the efficient production point

Question 5

What does Q” mean

Answer 5

Producing ABOVE the efficient production point

Question 6

What is Q*

Answer 6

the symbol for efficient production point

Question 7

What is P*

Answer 7

The symbol for efficient price point

Question 8

What is MC

Answer 8

marginal cost

Question 9

What is MWTP

Answer 9

marginal willingness to pay

Question 10

What is Pareto Optimality

Answer 10

another term for efficient allocation. The best possible allocation for all members of society

Question 11

What is Suboptimal allocation?

Answer 11

Another term for deadweight loss. Allocation is non-optimal and causes some loss to all members of society.

Question 12

What are the 3 main forms/ways the government can step in or not step in and cause/not cause market failure?

Answer 12

1. unintended policy impact - when the govt intervenes to try to solve one thing, but doesn’t realize they are causing another issue
2. Distortionary subsidies/taxes - direct subsidies that cause an overuse of a resource
3. Failure to correct pervasive market failures

Question 13

What is the producer subsidy equivalent?

Answer 13

If a domestic price is cheaper than an international price, this causes a producer subsidy.

IE: the US will produce more wheat than China if the price of production is cheaper in the US

Question 14

How can a subsidy impact the market?

Answer 14

It can change the efficient allocation point and move the marginal cost curve out.

Question 15

What are some reasons why market failures occur?

Answer 15

1. monopolies - when markets are dominated by one key seller/buyer, leading to distortion of market power
2. environmental externality - the cost of producing or consuming leads to environmental damage, which is then not reflected in the cost of the product
3. public goods - non-excludable and non-rival. example: overfishing in the open oceans

Question 16

What do we need for markets to function properly?

Answer 16

A fully functioning set of property rights

1. exclusivity (this pond is my pond and all benefits and costs of this pond go to me and only me to do with what I will)
2. transferability (I can voluntarily choose at any point to transfer part or all of my pond to someone else)
3. enforceability (my property rights secure me from involuntary seizure of my pond)

Question 17

Reasons why markets fail to exist:

Answer 17

1. lack of well defined property rights or lack of ownership
2. large distribution over time and space of costs and benefits
3. high transaction costs
4. imperfect information, risk, uncertainty and irreversibility

Question 18

What is a market externality?

Answer 18

occurs when the activities of one agent impact on the welfare of one or more other agents, but the impact is not taken into account and not compensated for