Markets and Efficiency (Unit 12) Flashcards
(17 cards)
Market failure
market forces of demand and supply fail to allocate resources efficiently, causing external costs and benefits
private costs
costs incurred by those
actively engaged in market production
external costs
a cost incurred by someone other than the producer
social costs
the true costs of production and consumption to society (sum of private and external costs)
external benefits
a benefit incurred by someone other than the consumer
public goods
goods and services that are non-excludable and non-rivalrous and which cause market failure because there is no profit incentive to produce them
merit goods
goods and services that produce positive externalities when consumed
externalities
cost or benefit imposed
on a person who does not play any role in the choice
why do externalities lead to market failure
There are no property rights or contracts for external costs and
benefits, leading to Pareto-inefficient outcomes
Marginal private cost (MPC)
The cost for the producer of producing an additional
unit of a good, not taking into account any costs its production imposes on others
Marginal external cost (MEC)
The cost of producing an additional unit of a good that is incurred by anyone other than the producer of the good
Marginal social cost (MSC)
the sum of themarginal private and external costs
In practice, most market failures cannot be solved through bargaining due to what factors?
- Impediments to collective action when market
failures impact many people. - Missing information about the size, source, and
incidence of the external cost. - Difficulties enforcing the bargain.
- Limited funds for the one party to compensate the
other
Pigouvian taxes
force individuals to pay the full
social cost of their actions on society and increase social welfare
Markets generate efficient equilibria
when:
- Contracts are complete.
- Transactions have no external effects.
- Buyers and sellers are price takers
what are 3 ways government tries to regulate inefficiencies?
- Government can ban production but this would not be
socially efficient: MSB > MSC when Q = 0. Some amount of
pollution is socially optimal! - Government can regulate the quantity by issuing production quotas or licenses, so that the efficient quantity is produced
- government can tax production of a product or specific inputs that are harmful
coase theorem
if property rights are well-defined and transaction costs are very low, then private parties can negotiate to solve externality problems efficiently — regardless of who holds the initial rights.
