Chapter 16

Question 1

The essence of the [ ] of free markets is that if all markets were perfectly competitive, and if governments allowed all prices to be determined by demand and supply, then price would equal marginal cost for all products and the economy would be allocatively efficient.

Answer 1

formal defence

Question 2

[. ] exists for a firm producing the output for which the price = marginal cost of production.

Answer 2

Allocative efficiency

Question 3

The informal defence of free markets is based on three central arguments:

Answer 3

(1) Free markets provide automatic coordination of the actions of decentralized decision makers.

(2) The pursuit of profits in free markets provides a stimulus to innovation and growth of material living standards.

(3) Free markets permit a decentralization of economic power.

Question 4

A [ ] provides automatic price signals as a situation develops so that not all of the consequences of an economic change have to be anticipated and allowed for by a group of central planners

Answer 4

free market

Question 5

[ ] describes a situation in which the free market, in the absence of government intervention, fails to achieve allocative efficiency.

Answer 5

Market failure

Question 6

The statement that the economy is allocatively efficient (or not) is a [ ] statement.

Answer 6

positive

Question 7

four situations in which the free market fails to achieve allocative efficiency

Answer 7

(1)market power, (2) externalities, (3) non-rivalrous and non-excludable goods, and (4) asymmetric information.

Question 8

Market power is inevitable in any market economy for three reasons.

Answer 8

(1) only a few firms can operate at low costs (2) firms sell differentiated products and thus have some ability to set their prices. (3) firms that innovate with new products gain a temporary monopoly

Question 9

An [ ] occurs whenever actions taken by firms or consumers directly impose costs or confer benefits on others.

Answer 9

externality

Question 10

Discrepancies between [ ], or between private benefit and social benefit, occur when there are externalities. The presence of externalities, even when all markets are perfectly competitive, leads to allocatively inefficient outcomes.

Answer 10

private cost and social cost

Question 11

With a [ ] social marginal costs are greater than private marginal cost. With a [ ] social marginal benefits are greater than private marginal benefits.

Answer 11

negative externality, positive externality,

Question 12

When there is an [ ], either too much or too little of the good is produced.

Answer 12

externality

Question 13

a situation where the production or the consumption of the good imposes costs on third parties. This is a [ ]

Answer 13

negative externality

Question 14

a situation where the production or consumption of the good confers benefits on third parties. This is a [. ]

Answer 14

positive externality

Question 15

With a positive externality, a competitive free market will produce [. ] of the good. With a negative externality, a competitive free market will produce [. ] of the good.

Answer 15

too little, too much

Question 16

(1) Example of Private Goods. (2) example of Common-Property Resources. (3) Club goods (4) Public Goods.

Answer 16

Food, Rivers and streams, Roads, National defence

Question 17

society’s marginal benefit of the good is the [ ]

Answer 17

sum of their own marginal benefits.

Question 18

Situations in which one party to a transaction has special knowledge are called situations of [ ]

Answer 18

asymmetric information.(the seller has more knowledge of the good being sold than the buyer.)

Question 19

[ ] exists when one party to a transaction has both the incentive and the ability to behave in a way that shifts costs onto the other party.

Answer 19

moral hazard

Question 20

[ ] refers to the tendency for people who are more at risk than the average to purchase insurance and for those who are less at risk than the average to reject insurance.

Answer 20

Adverse selection

Question 21

kinds of interference in the free choices of individuals are examples of [. ]

Answer 21

paternalism.

Question 22

Even if free markets generated [. ], they would be unlikely to generate outcomes consistent with most people’s social goals. Furthermore, there is often a tradeoff between achieving these social goals and increasing allocative efficiency.

Answer 22

allocatively efficient outcomes,

Question 23

The idea behind [. ] is simple: Add up the total costs, then add up the benefits, and implement the policy only if the benefits outweigh the costs.

Answer 23

cost-benefit analysis

Question 24

cost-benefit analysis is usually quite difficult for three reasons.

Answer 24

(1) what will happen when an action is undertaken. (2) costs and benefits occur only in the distant future and are therefore more complicated to assess. (3) some benefits and costs are difficult to quantify;

Question 25

There are three main ways in which government can alter the workings of the unrestricted market economy.

Answer 25

(1) public provision, (2) Redistribution Programs, (3) Regulation

Question 26

All forms of government intervention use real resources and hence impose [. ]

Answer 26

direct costs.

Question 27

government interventions in the economy impose costs on firms and households over and above the direct financial costs of the policy. Here are three examples.

Answer 27

1. Changes in Costs of Production, 2. Costs of Compliance, 3. Rent Seeking

Question 28

Evaluating the costs and benefits of government intervention requires a comparison of the free-market system as it [. ] with the pattern of government intervention as it [. ]

Answer 28

actually works, actually performs.

Question 29

What are the 4 types of goods

Answer 29

1. private tgoods
   - food, seat on airplane, car
   - Rivalrous, excludable
2. Common property goods
   - Wildlife, clean air
   - non-excludable, rivalrous
3. Club Goods
   - museums, roads
   - non-rivalrous, excludable
4. Public goods
   - police, public information
   - non rivalrous, non explicable

Question 30

What is optimal quantity of a public good?

Answer 30

MC of good = Sum if all users marginal benefit