Microeconomics - Externalities Flashcards
(19 cards)
What is market failure?
When the market fails to allocate scarce resources efficiently, causing a loss in social welfare loss.
What are the three main types of market failure?
Externalities, underprovision of public goods, information gaps.
What is underprovision of public goods?
Public goods are non-rivalry and non-excludable, meaning they are underprovided by the private sector due to the free-rider problem. The market is unable to ensure enough of these goods are provided. For example, streetlights.
What are Information Gaps?
Economic agents (consumers, firms, and governments) are assumed to have perfect information. But in reality, this is not the case, so economic agents do not always make rational decisions, and so resources are not allocated to maximise welfare. For example, consumers do not know the quality of secondhand products such as cars, so it’s difficult to know which one is best.
What is an externality?
The cost or benefit a third party recieves from an economic transaction outside of the market mechanism.
What are negative externalities caused by?
Demerit Goods. These are associated with information failure, as consumers are not aware of the long-run implications of the good. They are usually overprovided in the free market.
What are positive externalities caused by?
Merit goods. These are associated with information failure because consumers do not realise the long-run benefits of consuming the good. They are underprovided in a free market.
What are private costs/benefits?
The costs/benefits to the individual participating in the economic activity.
What are social costs/benefits?
The costs/benefits of the activity to society as a whole.
What are external costs/benefits?
The costs/benefits to a third party not involved in the economic activity. They are the difference between private costs/benefits and socialcosts/benefits.
How can the government intervene to ensure the market considers the external costs and benefits?
Indirect taxes & subsidies: taxes can be put on goods with negative externalities and subsidies on goods with positive externalities. These help to internalise the externalities, moving production closer to the social optimum position.
Tradable pollution permits: these allow firms to produce up to a certain amount of pollution and can be traded amongst firms to give them a choice whilst reducing the total level of pollution.
Provision of the good: When social benefits are very high, the government may decide to provide the good through taxation e.g. healthcare & education. & information: The government can provide information to help people make informed decisions since some externalities are associated with information gaps.
Regulation: this could limit consumption of goods with negative externalities.
Two features of public goods?
Non-rivalry: One person’s use of the good doesn’t stop someone else from using it.
Non-excludable: You cannot stop someone from accessing the good and someone cannot choose to access the good.
What is the free-rider problem?
You cannot charge an individual a price for the provision of a non-excludable good because someone else will gain the benefit from it without paying for anything—a free rider. Private sector producers will not provide public goods to people because they cannot be sure of making a profit due to the non-excludability of public goods. Therefore, if the provision of public goods was left to the market mechanism, the market would fail, and so they are provided by the government and financed through taxation.
What is symmetric information?
Occurs when buyers and sellers have potential access to the same information: this is perfect information. However many decisions are based on imperfect information and so economic agents are unabe to make a fully informed decision; information gap.
What is asymmetric information?
When one party has superior knowledge compared to another. Usually, the seller has more information than the buyer, and this means they can take advantage of the other party’s lack of knowledge by charging them a higher price.
How does advertising lead to an information gap?
Most advertising leads to information gaps as it is designed to change attitudes of the consumers to encourage them to buy the good. It could cause them to think the benefits are greater than they actually are. Increases in technology mean information gaps are on the decline as people can get more information.
How do information gaps lead to market failure?
There is a misallocation of resources because people do not buy things that maximise their welfare. It means that consumer demand for a good or producer supply of a good may be too high or too low, and thus quantity is not at the social optimum position. Economic agents are unable to make rational decisions due to the information gap.
What is the principal-agent problem?
When the goals of the principal (the person who gains/loses from the decision) are different from the agents (those making decisions on behalf of the principal). For example, education, where the child is the principal and the agents are parents/governments: the child has imperfect information, as they do not see the benefits of education and therefore will devote too few resources to education, if allowed.
