Chapter 10

Question 1

allocation function

Answer 1

government production of goods or regulation of business, aimed
at improving the allocative efficiency of the economy (i.e., getting the “right mix” of
products produced, each in the “ideal quantity” and at the “ideal quality”).

Question 2

distribution function

Answer 2

government policies aimed at changing the final distribution of
goods/services across consumers, usually with the intention of realizing a “fairer”
apportionment of consumption/income/wealth.

Question 3

stabilization function

Answer 3

attempts by government to minimize fluctuations in overall
macroeconomic activity.

Question 4

market failure

Answer 4

a situation in which the “free market outcome” is inefficient, in that
there is a positive Deadweight-Loss at the resulting “free market level of trade.”

Question 5

market power

Answer 5

A firm has market power if they have some “control over the price of
their output,” in that they: (i) can increase price without losing all customers and
(ii) must decrease price in order to increase sales

Question 6

monopoly

Answer 6

market structure in which there is one single seller of a unique good with
no close substitutes.
▪ The “polar opposite” of “perfect competition.”
▪ The demand curve facing a monopolist is the market demand curve.
▪ They can choose any price/quantity combination along the market demand curve

Question 7

profit

Answer 7

the difference between revenues and costs of production

Question 8

marginal revenue

Answer 8

the amount by which revenue changes as the firm’s quantity of
output is increased by a unit

Question 9

marginal costs of production

Answer 9

the amount by which production costs change as the
firm’s quantity of output is increased by a unit

Question 10

non-rival good

Answer 10

a good for which consumption by one person does not diminish the
quantity or quality of consumption by others

Question 11

rival good

Answer 11

a good for which consumption by one person does diminish the quantity
or quality of consumption by others

Question 12

non-excludable good

Answer 12

a good for which it is difficult (or very costly) to prevent
consumption by those who do not pay

Question 13

excludable good

Answer 13

a good for which it is easy to prevent consumption by those who do
not pay

Question 14

private good

Answer 14

a good that is excludable and rival in consumption.

Question 15

public good

Answer 15

a good that is non-excludable and non-rival in consumption
▪ e.g., national defense

Question 16

club good

Answer 16

a good that is excludable and non-rival in consumption
▪ e.g., satellite radio or television broadcast

Question 17

common good

Answer 17

a good that is non-excludable and rival in consumption
▪ e.g., stock of fish in the ocean

Question 18

free rider problem

Answer 18

if a public good were supplied in a free market, the amount
traded would be less than the efficient quantity, since many people would attempt to
enjoy the benefits of units purchased by others, while not purchasing any units
themselves

Question 19

externality

Answer 19

a benefit or cost that is realized by someone who is not
directly engaging in an activity

Question 20

negative externality

Answer 20

a cost of an activity borne by someone not engaging in
the activity.
▪ examples: pollution, noise from low-flying aircraft, speeding on a highway,
installation of “The Club” in a car

Question 21

positive externality

Answer 21

a benefit from an activity realized by someone not engaging
in the activity
▪ examples: vaccines, installation of smoke detector in an “attached
apartment,” installation of Lojack in a car

Question 22

internalizing a externality

Answer 22

policies which introduce a cost (or foregone gain)
that is realized if the person continues to generate a negative externality

Question 23

Coasian Solution to the Problem of Externalities

Answer 23

Ronald Coase (1910-2013; Noble
Prize in 1991; Professor Emeritus at Univ. of Chicago Law School) argued that problems
of externalities are at their core due to undefined property rights and can be address by the
following approach:
i. clearly and fully define property rights
ii. make individuals pay compensation if they infringe upon the property rights of
others
iii. allow parties to negotiate with one another regarding infringements on property
rights caused by the externality
▪ Coase showed that regardless of which party is given the property right, negotiation
between the parties will result in the efficient level of the externality (so long as the
costs of negotiation and enforcement are low enough)
▪ defining property rights and allowing parties to negotiate essentially “internalizes
the externality”

Question 24

market failure due to lack of information

Answer 24

for some goods consumers may have
difficulty knowing their “true reservation price” => especially common for goods
purchased infrequently or for which quality is difficult to observe (e.g., house, car,
education, medical procedure, meal at a restaurant
▪ when consumers lack accurate information about costs or benefits of consuming a
good, they may fail to make efficient choices in the marketplace
▪ Further note, “information” is often a “club good” (non-rival in consumption
and excludable).
o Once a club good is produced, the additional cost of providing it to the next person
is essentially zero => to maximize social surplus, everyone who has a positive
value for the information should be able to access it
o Additionally, as long as the information is accurate, total costs to society are
minimized if the information is only generated once (e.g., it is a waste of resources
to have both the National Weather Service and AccuWeather come up with
weather forecasts)
* In such cases, have government license, inspect, and/or regulate providers of
such goods in order to:
i. provide people with the important information needed to make good
decisions in markets and
ii. minimize the costs to society of providing the information
o e.g., “Cobb and Douglas Public Health” inspects restaurants and assigns letter
grades based upon compliance with health codes => government “regulates
product” and “provides information