Unit 12: Markets, Efficiency & Public Policy Flashcards
(21 cards)
What is an externality?
An external effect of an economic decision not included in the contract.
What does MSC = MPC + MEC mean?
Marginal Social Cost equals Marginal Private Cost plus Marginal External Cost.
When does a negative externality occur?
When MSC > MPC, leading to overproduction.
What is the Coase Theorem?
Private bargaining over externalities can lead to efficient outcomes if transaction costs are low.
What are limits to Coasean bargaining?
Transaction costs - costs of acquiring information, enforcing the contract, or collective action.
Missing information – calculating the exact costs imposed on each fisherman and each plantation’s contribution to pollution.
Enforcement – it may be difficult for a court to determine whether plantations have complied or not.
What is a Pigouvian tax?
A tax on a firm generating negative externalities to correct market failure.
What is a Pigouvian subsidy?
A subsidy to encourage firms that generate positive external effects.
Why are incomplete contracts a problem?
They fail to capture all social costs/benefits due to unverifiable or asymmetric information.
What is a public good?
A good that is non-rival and non-excludable.
Why do public goods cause market failure?
Because they are underprovided due to the free-rider problem.
What is asymmetric information?
When one party in a transaction has more relevant information than the other.
What is moral hazard?
When hidden actions lead to riskier behavior post-contract (e.g. careless driving after insurance).
What is adverse selection?
When sellers have information that buyers don’t have, or vice versa (e.g. sick people buying life insurance, or second hand car dealers).
What is a missing market?
When the market fails to provide a MSB good or service due to the inability of private firms to capture the full value of their investment.
How does the banking system exhibit moral hazard?
Banks take more risks expecting bailouts because of systemic importance.
What happens when P > MC?
There is inefficiency and deadweight loss due to market power or monopoly.
What is a natural monopoly?
A market where one firm can supply the good more efficiently than many due to economies of scale.
What are merit goods?
Goods that should be provided to everyone regardless of ability to pay, like education.
What are repugnant markets?
Markets that violate social norms or ethics (e.g. slavery).
What is the role of government in market failure?
To regulate, tax, subsidize, or compensate to correct inefficiencies.
Why might markets not allocate all goods efficiently?
Due to externalities, incomplete contracts, asymmetric info, and ethical limits.
