Chapter 16: Market Failures and Government Intervention Flashcards
What is the basic function of the government in microeconomics?
to guarantee a secure framework of law/order, and well-defined and enforced property rights
Why is building an institution difficult in developing countries?
Ineffective political structures
Define the concept of allocative efficiency?
Resources are used in a way that maximizes total surplus to society
If all markets were perfectly competitive and governments allowed all prices to be determined by supply/demand, then prices would be equal to the marginal costs for all products and the economy would be allocatively efficient
What is market failure?
The failure of the unregulated market system to achieve allocative efficiency
Firms with market power will typically ____ output and lead to allocative _____
reduce
inefficiency
True/False? Market power is inevitable
Give 3 reasons why/not
True
In many industries economies of scales are such that there is only room for a few firms to operate at low costs
Firms sell differentiated products and thus have some ability to set prices
Firms that innovate with new products or new production processes gain a temporary monopoly until other firms learn what the innovator knows
What is externality?
When actions taken by firms or consumers impose costs or confer benefits on third parties
Positive: Helpful
Negative: Harmful
eg smoker gives second hand smoke
eg gardener does neighbour’s garden
What are two externalities faced in microecenomics?
Private costs: Costs faced by private decision maker
Social costs: Includes private costs and nay other costs imposed to third parties
What happens during a negative externality?
Social marginal costs are greater than private marginal costs
Eg firm produces harmful smoke: people living near firm bear real costs because of the smoke, but the firm will set their output to maximize profits without thinking about the social costs (other than their private cost)
Excess supply
What happens during a positive externality?
Social marginal costs are less than private marginal costs
Eg person renovates her home and improves appearance, neighbors improve their view and value of neighbor’s properties increase, the person who renovated ignores the benefits that her actions have on her neighbors
Excess demand
How can the government correct a negative externality? A positive externality?
Negative: tax on outcome
Positive: Subsidies
