Chapter 5

Question 1

What is the major advantage of the price system?

Answer 1

It allows all resources to move from lower-valued uses to higher-valued uses via a voluntary exchange, by which mutually advantageous trades take place.

Question 2

In the price system, consumers are _____.

Answer 2

Sovereign.

Question 3

Give the definition of a “market failure.”

Answer 3

A situation in which an unrestrained market operation leads to either too few or too many resources going to a specific economic activity.

Question 4

How do market failures affect the price system?

Answer 4

They prevent the price system from maximizing efficiency and don’t allow economic freedom among consumers.

Question 5

In a pure market system, competition generates economic efficiency only when ___________.

Answer 5

Individuals must know and bear the true opportunity cost of their actions.

Question 6

What is an externality?

Answer 6

A consequence of an economic activity that spills over to affect third parties.

Example: A coal-burning steel plant causing respiratory illness in surrounding communities.

Question 7

What is the general definition of “property rights?”

Answer 7

The rights of an owner to use and to exchange property.

Question 8

A negative externality on a producer would shift the supply curve _____.

Answer 8

Left

Question 9

Positive externalities can shift demand curves to the ______.

Answer 9

Right

Question 10

When there are external costs, the market will tend to ______ resources to the production of the good or service in question, for those goods and services are implicitly priced deceptively low.

Give an example.

Answer 10

Overallocate

For the dirty steel mill, the owners are not taking into account the cost of pollution to the community. Therefore the price of steel will be lower. More steel will be produced and sold than if the sellers were forced to bear the external costs.

Question 11

When there are external benefits, the price is too ____ to induce suppliers to allocate resources to the production of that good or service. Explain why.

Answer 11

Low

Because the demand, which fails to reflect the external benefits is too low.

Question 12

For a positive externality, the market tends to _____resources.

Answer 12

Underallocate

Question 13

Summarize the relationship between externalities, and what a free market will generate on their behalf.

Answer 13

In a market system, too many of the goods that generate external costs are produced, and too few of the goods that generate external benefits are produced.

Question 14

What are the two avenues available to a government to correct negative externalities?

Answer 14

1. Special taxes

2. Legislative regulation/prohibition

Question 15

In the example of the steel mill, the externality arises because ____________.

Answer 15

Using the air for waste disposal is costless to the firm but not to society.

Question 16

What is an effluent fee?

Answer 16

A charge to a polluter that gives them the right to discharge into the air or water a certain amount of pollution.

Question 17

What is the effect of an effluent fee on the supply and price of a given product?

Answer 17

Since the firm now has added costs the supply curve with shift left causing an increase in the equilibrium price and a decrease in the equilibrium quantity.

Question 18

What are some ways that government can correct positive externalities?

Answer 18

1. Government financing and production
2. Regulation
3. Subsidies

Question 19

Property rights can be described as the “_____” for a free market system.

Answer 19

Rules of the game

Question 20

True or False

Providing a sound legal system is part of the government’s economic function.

Answer 20

True

Question 21

What is “anti-trust” legislation?

Answer 21

Laws that restrict the formation of monopolies and regulate certain anti-competitive business practices.

Question 22

What is a “monopoly?”

Answer 22

A firm that can determine the market price of a good. In the extreme case, a monopoly is the only seller of a good or service.

Question 23

What is the definition of a “private good?”

Answer 23

Goods that can be consumed by only one individual at a time.

Question 24

Private goods are subject to the principle of ______.

Answer 24

Rival consumption.

Question 25

What is the principle of rival consumption?

Answer 25

The fact that individuals are rivals in consuming private goods because one person’s consumption reduces the amount available or others to consume.

Question 26

What is a “public good?”

Answer 26

Goods for which the principle of rival consumption does not apply and for which exclusion of non-paying consumers is too costly to be feasible.

Question 27

What are the two fundamental characteristics of public goods?

Answer 27

1. Public goods can be used by more and more people at no additional opportunity cost and without depriving others of any of the services of the good itself.
2. It is difficult to design a collection system for the public good on the basis of how much individuals use it.

Question 28

What is the fundamental problem with public goods?

Answer 28

The private sector has a very difficult time providing them.

Question 29

The nature of public goods leads to the _____ problem.

Answer 29

Free-rider

Question 30

Define the “free-rider problem.”

Answer 30

A problem that arises when individuals presume that others will pay for public goods so that individually, they can escape paying for their portion without causing a reduction in quantity supplied.

Question 31

What are the two political functions of government that affect economics?

Answer 31

1. Provision of government-sponsored and prevention of government-inhibited goods.
2. Income redistribution

Question 32

What is a government-sponsored good?

Answer 32

A good that has been deemed socially desirable through the political process.

Example: Meuseums

Question 33

What are government-inhibited goods?

Answer 33

A good that has been deemed socially undesirable through the political process.

Example: Illegal drugs

Question 34

How does the government redistribute income?

Answer 34

1. Progressive income tax

2. Transfer payments

Question 35

With respect to the government’s role in income redistribution, what is the definition of “transfer payments?”

Answer 35

Money payments made by the government to individuals for which no services or goods are rendered in return.

Examples: Social security, disability benefits, unemployment benefits, etc.

Question 36

With respect to the government’s role in income redistribution, what is the definition of “transfer in kind?”

Answer 36

Payments from the government that are in the form of actual goods and services.

Examples: Food stamps, subsidized housing, etc

Question 37

What is a government outlay?

Answer 37

All government expenditures on social programs.

Examples: employees, rent, electricity, welfare, social security, etc.

Question 38

What are government/political goods?

Answer 38

Goods provided by the public sector.