Lesson 2 Flashcards
(27 cards)
definition market failure
when the allocation of goods and services by the free market doesn’t achieve the efficient allocation (no Pareto efficiency)
examples of market with market failure
- monopoly (1 producer)
- oligopoly (few producers)
- monopsony (1 buyer (labour market))
- cartels (collaboration to set prices)
- product differentiation
welfare loss due to monopoly
- consumer surplus (above price/demand point) decreases
- producer surplus (under price/demand point) increases, but not enough to offset consumer surplus
- small triangle with deadweight loss (total loss)
definition asymmetric information
= when someone doesn’t have the same level of information
definition adverse selection
= one party know the hidden attributes better than the other (quality of a good, skill-level of a worker)
- asymmetric info is a part of adverse selection
–> problem: buyer doesn’t know which cars are good or bad –> dissolution of the marketing (skeptical consumers are only willing to pay a low price, also food good quality cars)
–> solution: good quality cars can make decision that credibly signal the quality (official car store, certificate)
Moral hazard defintion
= situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk (most common from insurance markets, with asymmetric info)
implications of asymmetric info
- market can be inefficient (dissolution of market/low activity OR prices higher than marginal costs)
- market may not even exist at all (unemployment)
solution asymmetric info
engage in costly actions (signaling) –> credible reveal private information
4 categories of goods
- private good (excludable and rival)
- ice-cream, clothing, congested toll roads - public good (no excludable, no rival)
- fireworks, knowledge, uncongested non toll roads - common resources (no excludable, but yes rival)
- fish in the ocean, environment, congested nontoll roads - natural monopolies (yes excludable, but no rival)
- cable tv, uncontested toll roads
5 considerations for public goods
- public goods are shared equally, but often not valued equally (national defense spending)
- the publicness of a good depends on degree and condition (too crowded lowers quality, you put a fence in it/admission)
- a particular commodity (for whole society) can be non-rival but excludable or other way around public goods may not be what I think of as goods at all (like a fair income distribution, democracy)
- the sect that produces/provides isn’t what determines if it’s private or public good
efficient provision public vs. private good
Private = each person decides how much to consume based on their personal benefit vs. price.
The market outcome is efficient (under ideal conditions) because price = marginal cost
Public= everyone benefits from the same unit → we must sum everyone’s willingness to pay.
Efficient provision happens where: Sum of all individuals’ Marginal Benefits = MC
solution for problem of the free rider
perfect price discrimination
- assume seller knows individual values (which is often difficult)
- assume the good isn’t easy to transfer
- then charge each person their own individual value.
what is the problem of the free-rider
Some individuals try to avoid paying for a good and wait for other to pay for it (because you can’t alway prevent people from using/enjoying a public good)
–> makes it difficult for private markets to provide public goods
meaning cost benefit analysis
to decide if government provides a pubic good, the benefits should be compared with the total costs of the good
- impossible to calculate social benefits/costs
- difficult to give economic value to human life, time of consumers etc.
2 take-away points for public goods
- room for government intervention doesn’t mean that we know how to intervene
- free rider problem exists –> smaller in practice than economic theory implies
meaning tragedy of the commons
dilemma that shows why the common resources are used more intensively than what would be desirable from a social point of view (video fish in a lake)
–> when a person uses a common resource, he diminishes other people’s joy of it (overexploitation when individuals don’t pay for it) –> negative externality
definition externalities
they arise if the choices of production/consumption of some agents have collateral effects on other agent
- negative: impact is adverse
- positive: impact is beneficial mechanism –> they will just raise the price for others
externalities in production
difference between social and private costs
- negative: social cost higher than private costs
- positive : social cost lower than private cost
example aluminum and negative externality
If there’s a negative externality: social cost of production is higher than the private cost
- social costs= private costs of producer + cost of pollution
- production of aluminum higher than optimum (price demand point = equilibrium) –> optimum is new point
externalities effect on economic welfare
–> producers/consumers don’t take into account the external effects of their choices (they don’t produce optimal quantity)
- extra pollution damage caused by extra units produced (difference between equilibrium and optimum)
- producers looses surplus by being force to produce less, however we gain surplus as well
example robots as positive externality
positive externality: social cost of producing is smaller than private cost
- social cost includes includes private cost - benefits of diffusion of a new technology
- production of robots smaller than the optimum
meaning the importance of property rights
rights not well established –> markets fail to provide resources efficiently
- example: smkoking (who has the right: the smoker to smoke or the non-smoker to clean air) –> what is best to do
solution: government intervention (laws)
how to solve externalities?
- internalize them: modification of incentives to make agents Taki into account the effect of their choices
- can be private (moral codes, charities, the case theorem) or public
