Macro 1.3

Question 1

What is market failure?

Answer 1

Market failure occurs when the free market fails to allocate resources to the best interests of society, leading to an inefficient allocation of scarce resources.

Economic and social welfare is not maximized where there is market failure.

Question 2

What are the types of market failure?

Answer 2

• Externalities
• Under-provision of public goods
• Information gaps

Question 3

Define externality.

Answer 3

An externality is the cost or benefit a third party receives from an economic transaction outside of the market mechanism.

Question 4

What is the free-rider problem?

Answer 4

The free-rider problem occurs when public goods are non-excludable and non-rival, leading to individuals benefiting without paying.

Question 5

What are private costs?

Answer 5

Private costs are the costs to economic agents involved directly in an economic transaction.

Question 6

Define social costs.

Answer 6

Social costs are calculated by private costs plus external costs, representing the cost to society as a whole.

Question 7

What is the social optimum position?

Answer 7

The social optimum position is where marginal social costs (MSC) equal marginal social benefits (MSB), indicating maximum welfare.

Question 8

True or False: External costs increase disproportionately with increased output.

Answer 8

True

Question 9

What are external benefits of consumption?

Answer 9

External benefits of consumption are positive effects on third parties from the consumption of a good or service.

Question 10

What is the purpose of indirect taxes in relation to negative externalities?

Answer 10

Indirect taxes aim to reduce the quantity of demerit goods consumed by increasing the price of the good.

Question 11

Fill in the blank: Public goods are _______ and _______.

Answer 11

non-excludable, non-rival

Question 12

What are quasi public goods?

Answer 12

Quasi public goods have characteristics of both public and private goods, being partially provided by the free market.

Question 13

Define asymmetric information.

Answer 13

Asymmetric information occurs when there is unequal knowledge between consumers and producers, leading to market failure.

Question 14

What is the effect of imperfect information on economic decisions?

Answer 14

Imperfect information leads to a misallocation of resources as informed decisions cannot be made.

Question 15

What is the relationship between private benefit and private costs?

Answer 15

Private benefit is derived from the consumption of a good and is influenced by the price the consumer is willing to pay.

Question 16

What are social benefits?

Answer 16

Social benefits are private benefits plus external benefits, reflecting the total benefit to society from consumption.

Question 17

What is deadweight welfare loss?

Answer 17

Deadweight welfare loss occurs when the output where social costs exceed private benefits is not accounted for, leading to inefficiency.

Question 18

What role do property rights play in market efficiency?

Answer 18

Property rights encourage innovation as entrepreneurs can protect their ideas and earn profit.

Question 19

What is a common challenge in measuring public goods?

Answer 19

It is difficult to measure the value consumers get from public goods, making it hard to assign a price.

Question 20

True or False: Negative externalities can lead to over-provision and under-pricing of goods.

Answer 20

True

Question 21

What is the significance of consumer information in economic decisions?

Answer 21

Providing information ensures that there is no information failure, allowing informed economic decisions.

Question 22

What are the implications of government policies on externalities?

Answer 22

• Indirect taxes to reduce demerit goods
• Subsidies to encourage merit goods
• Regulation to enforce less consumption

Question 23

What happens when external costs are not internalized in the market?

Answer 23

The market fails to account for negative externalities, leading to social costs exceeding social benefits.

Question 24

Fill in the blank: Consumers may undervalue the benefit of a public good, leading them to pay _______.

Answer 24

less

Question 25

What is asymmetric information?

Answer 25

A situation where one party has more or better information than another, leading to misallocation of resources. ## Footnote This often affects consumers and producers differently in market transactions.

Question 26

What can result from imperfect information?

Answer 26

Misallocation of resources, consumers paying too much or too little, and firms producing the incorrect amount. ## Footnote An example includes monopolies exploiting consumers by overcharging.

Question 27

Define the principal-agent problem.

Answer 27

A situation where an agent makes decisions on behalf of a principal but acts in their own interests rather than those of the principal. ## Footnote This often occurs between shareholders and managers.

Question 28

What is a consequence of the principal-agent problem?

Answer 28

Managers may prioritize personal gain over maximizing shareholder dividends. ## Footnote This can lead to conflicts of interest within a company.

Question 29

How can information be made more widely available?

Answer 29

Through advertising or government intervention. ## Footnote For instance, public health messages about smoking can inform consumers.

Question 30

What is moral hazard?

Answer 30

When a party with superior knowledge changes their behavior to benefit themselves at the expense of another party with inferior knowledge. ## Footnote This is commonly observed in insurance markets.

Question 31

True or False: Asymmetric information can lead to moral hazard.

Answer 31

True. ## Footnote Moral hazard arises when one party's superior information results in changes in behavior that disadvantage another party.

Question 32

Fill in the blank: Asymmetric information can lead to _______ where consumers are unaware of the true costs or benefits.

Answer 32

misallocation of resources.

Question 33

What might consumers know more about than producers when purchasing insurance policies?

Answer 33

The risks associated with their own health or circumstances. ## Footnote This knowledge imbalance can affect insurance pricing and availability.