Micro Ch. 16 Market Failure & Gov Intervention

Question 1

1 discuss the importance of the government’s “monopoly of violence.”

2 describe the “informal” defence of free markets.

3 explain why externalities lead to allocative inefficiency.

4 explain why public goods are underprovided by private markets.

5 describe how information asymmetries can lead to market failures.

6 understand why free markets may not achieve some desirable social goals.

7 identify the direct and indirect costs of government intervention, and some of the important causes of government failure.

Question 2

The operative choice is not between an unhampered free-market economy and a
fully centralized command economy. It is rather…

Answer 2

the choice of which mix of markets
and government intervention best suits people’s hopes and needs.

Question 3

When the government’s monopoly of violence is secure and functions with effective restrictions against its arbitrary use, citizens can …

Answer 3

safely carry out their ordinary economic and social activities.

Question 4

Two duties of sovereign

Answer 4

1. protecting society from violence and invasion of other independent countries
2. protecting, as far as possible, every member of the society from the injustice or oppression of every other member of it.

Question 5

Free market formal defence

Answer 5

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.

Question 6

Free market informal defence

Answer 6

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 7

Market Failure

Answer 7

failure of the unregulated market system to achieve allocative efficiency

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

Question 8

externality

Answer 8

an effect on parties not directly in the production of or use of a commodity. Also called third-party effects

Question 9

private cost

Answer 9

The value of the resources used in production as valued by the producer

Question 10

social cost

Answer 10

includes private costs to producers plus any external costs imposed on third parties

Question 11

Discrepancies between private cost and social cost, or between private benefit and social benefit, occur when…

Answer 11

there are externalities. The presence of externalities, even when all markets are perfectly competitive, leads to allocatively inefficient outcomes.

Question 12

With a positive externality, a competitive free market will produce too

Answer 12

little of the good.

Question 13

With a negative externality, a competitive free market will produce too

Answer 13

much of the good.

Question 14

Rivalrous

Answer 14

a good or service is rivalrous if one person’s consumption reduces the amount for others

Question 15

Excludable

Answer 15

a good or service is excludable if its owner can prevent others from consuming it

Question 16

Private goods

Answer 16

a good. or service that is both rivalrous & excludable
*pose no particular problem for public policy

Question 17

Common property rescources

Answer 17

A product that is rivalrous but not excludable
*Common-property resources tend to be overused by private firms and consumers.

Question 18

public goods

Answer 18

goods or services that can simultaneously provide benefits to a large group of people. Also called collective consumption goods.

Question 19

Free-rider problem

Answer 19

Since public goods are (by definition) not excludable, it is impossible to prevent anyone from using them once they are provided. If the provider charged a price, non-payers would take a free ride at the expense of those individuals with a social conscience who do pay.

*Because of the free-rider problem, private markets will usually not provide public goods. In such situations, public goods must be provided by government.

Question 20

Asymmetric information

Answer 20

situation in which one party to a transaction has more or better information about the transaction than the other party.

Question 21

moral hazard

Answer 21

a situation in which an individual or a firm takes advantage of special knowledge while engaging in socially inefficient behaviour

Question 22

Adverse selection

Answer 22

Self-selection, within a single risk category, or persons of above-average risk

Question 23

Even in the absence of market failures, the government may choose to intervene in markets to achieve broader…

Answer 23

social goals.

Question 24

Paternalism

Answer 24

Intervention in the free choices of individuals by others (including governments) to protect them against what is presumed to be their ignorance or folly

Question 25

Even if free markets generated allocatively efficient outcomes, they would be (1)_________ to generate outcomes consistent with most people’s (2)_______ ________. Furthermore, there is often a tradeoff between achieving these social goals and increasing (3)_________ ________.

Answer 25

1. unlikely
2. social goals
3. allocative efficiency

Question 26

cost-benefit analysis

Answer 26

an approach for evaluating the desirability of a given policy, based on comparing total (opportunity) costs with total benefits.

Question 27

Government Intervention - Public provision

Answer 27

National defence, the criminal justice system, public schools, universities, the highway system, and national parks are all examples of goods or services that are provided by governments in Canada. Public provision is the most obvious remedy for market failure to provide public goods, but it is also often used in the interest of redistribution and other social goals (e.g., public education and healthcare services, neither of which are public goods as defined earlier in the chapter). We will consider public spending in detail in Chapter 18.

Question 28

Government Intervention - Redistribution programs

Answer 28

Taxes are often used to alter the distribution of income generated by the free market. High-income people generally pay income taxes at a higher rate than do low-income people, with the lowest-income earners paying no income taxes at all. Government transfer programs also affect the distribution of income, usually by making direct payments to lower-income individuals and families. We examine the distributive effects of the Canadian tax-and-transfer system in Chapter 18.

Question 29

Government Intervention and Costs

Answer 29

All forms of government intervention use real resources and hence impose direct costs.

Question 29

Government Intervention - Regulation

Answer 29

Government regulations are public rules that apply to private behaviour. In Chapter 12, we saw that governments regulate private markets to limit the use of monopoly power. In Chapter 17, we will focus on regulations designed to deal with environmental degradation. Among other things, government regulations prohibit minors from consuming alcohol, require that children attend school, penalize racial discrimination in housing and labour markets, set standards for food and drug safety, prevent commercial banks from excessively risky lending activities, establish minimum standards for home construction, and require that all cars have seat belts. Government regulation is used to deal with all of the sources of market failure that we have discussed in this chapter; it applies at some level to virtually all spheres of modern economic life.

Question 30

Indirect Costs - Changes in Costs of Production