week 9 Market failure

Question 1

Externality

Answer 1

an externality is present if a variable that affects some decision makers utility or profit is directly under the control of another agent.

This effect is not mediated by a competitive market

externality if increases or reduces utility

e.g smoking in somones face decrease utility

Question 2

tragedy of the commons

Answer 2

A common right of access to a resource leads to overuse

Question 3

bandwagon effect

Answer 3

Wrong standards being adopted.

- designed to slow typists down to stop key's jamming (max distance between commonly used letters to slow down typists)
- dvoraks's keyboard is 5-10% faster, but typists would have to retrain.
- Less attractive product
- Less incentive to retrain Caused by network externality

Question 4

Pigouvian tax

Answer 4

a tax to align a divergence between social and private cost/benefit to make market equilibrium efficient

e.g tax or subsidy

Question 5

issues when implementing pigouvian tax

Answer 5

Personalised prices, to achieve social optimum need fully personalised price. Each individual needs a tax that differs from others.

Also differentiational by consumer and externality e.g different taxes for particular goods

Very difficult to implement as need information from everyone

Question 6

what is used instead of pigouvian tax

Answer 6

Have to use Second best polices,

Restrict policy space which is still an improvement on current equilibrium and closer to socially optimum

Uniform tax may move closer to socially optimum
Or market intervention e.g renewable fuels to tackle air pollution

Question 7

Behavioral economics on pricing that offer holes in pigou tax

Answer 7

Negative externality; parents picking up children late from nursery, staff stay longer without pay

Pigou-use tax

Policy- small fee charged to parents who were late

Outcome- twice as many parents were late

Since parents paid price for it, they felt entitled to leave kids longer

Positive externality- most benefits of donating blood goes to others

Pigou- Use subsidy

Policy- paid for each litre donated

50% less women donated blood

Tried to encourage but worked in opposite way, once price put on doing something good it turns into a market transaction.

Question 8

Internalisation

Answer 8

Could merge agent who cause the externality with the one that’s affected by it.

Ex. Bee keeper near orchard

The tress help bees, bees help trees

Merge bee keeper and orchard owner, into 1 firm and joint profit function maximisation leads to socially optimum outcome.

Problems
-monopoly power, DWL gains from externality reduction
Agents may have preference, noisy neighbours- if suggested to make one big house wouldn’t be good.

Question 9

coase theorm

Answer 9

In competitive market with complete information and zero transaction costs, the allocation of resources will be efficient and invariant with respect to legal rules of entitlement

- Essentially saying policy just needs to enforce property rights, to fix externality   if conditions hold. Will end up with efficient outcome
- e.g. individual pays another to stop smoking leading to efficiency. Bargain with individual whose property right has been violated

- Factory near house

b- Firm polluting, C- household’s costs from it

-pollutee-pays if C>B householder pays firm to stop polluting, otherwise it’ll continue. (permissive property right- firm allowed to pollute by govt)

Polluter-pays (restrictive property right, household is entitled to clean environment), if B>C, firm will be willing to pay householders to pollute otherwise it’ll stop.

Question 10

practical issues with coase and internalisation

Answer 10

Property rights hard to define, enforce and monitor. e.g. air pollution

Lots of transaction costs in practice- e.g. lawyer costs

Often large groups effected, so hard to reach agreement.

Question 11

Public goods

Answer 11

Definition- a pure public good is non excludable (e.g. can’t stop someone else benefiting) and non-rivalrous (consumption of good doesn’t reduce availability for another)e.g Streetlight

Question 12

why is provision of public goods inefficeint

Answer 12

• If firm supplies public good to 1 consumer it supplies to all but cannot charge anyone but the first consumer. Once it’s their no-one else is willing to pay
  
  • First consumer has no objection to other consuming
  • Therefore it prevents the equalisation of marginal valuations e.g. its inefficient. Cant capture value of all consumers of good

Question 13

impure public good

Answer 13

an impure public good is one that eventually suffers congestion or excludable at a cost.

Question 14

private good

Answer 14

a good that is excludable and rival-consumption- chocolate bar.

Question 15

ex. private provision of public good

Answer 15

flowers outside somones house

Question 16

public provision of public good

Answer 16

govt chooses how much to produce, levying taxes etc.

Question 17

free riding

Answer 17

Since consumers share consumption each has an incentive to rely on others to purchase free goods, free-riding.

Question 18

what is efficient

Answer 18

Points of tangency between indifference curves are efficient as it is impossible to make a Pareto improvement.

Doesn’t mean the marginal rates of substitution are the same at those points.

Efficiency is characterised by the Samuelson rule…

MRS1^1(g,x) +MRS2^1(g,x) =MRT(g,x)

Equals marginal sate of transformation, the rate at which you can turn one good into another, private goods into public goods.

LHS, marginal benefit of a unit of public good- buy unit it goes to both consumers, look at both peoples benefits

RHS- marginal cost of a unit of public good, here 1 unit of private good ( could be different for different examples)