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Chapter 4 Market Failures: Public Goods and Externalities

Market Failures
when economically desirable goods are not produced at all. They are overproduced or under-produced.
Demand-Side Market Failure
When demand curves do not reflect consumers’ full willingness to pay for good service
Supply-side Market Failure
when supply curves do not reflect the full cost of producing a good or service
Consumer surplus
the difference between the maximum price a consumer is willing to pay for a product and the actual price that they do pay
How are consumer surplus and price related?
Inversely (negatively)
How are consumer surplus and prices inversely related?
Higher prices reduce consumer surplus, lower prices increase consumer surplus.
Producer Surplus
The difference between the actual price a producer receives and the minimum acceptable price that a consumer would have to pay.
How are producer surplus and equilibrium price related?
Directly (positively)
How are producer surplus and equilibrium price directly related?
Lower prices reduce producer surplus and higher prices increase producer surplus
Productive Efficiency
Achieved when competition forces producers to use the best technologies and combinations of resources available.
What does productive efficiency do
minimizes the per-unit cost of the output produced.
Allocative Efficiency
Achieved when the correct of product is produced relative to other goods and services
When does Allocative efficiency occur at the market equilibrium quantity?
1) MB = MC
2) Maximum willingness to pay = Minimum acceptable price
3) Total surplus is at maximum
Efficiency Losses
Reductions of combined consumer and producer surplus
When does efficiency loss occur?
from both underproduction and overproduction
What is another name for efficiency loss?
deadweight loss
Private Goods
Goods offered for sale in stores, shops, internet.
Rivalry
when a person buys and consume a product, it is not available for another person to buy and consume
Excludability
Sellers can keep people who do not pay for a product from obtaining its benefits
The market demand for a private good is
the horizontal summation of the individual demand schedules.
Public Goods
Distinguished by nonrialry and nonexcludability.
Nonrivalry
One person’s consumption of a good does not preclude consumption of the good by others
Nonexcludability
There is no effective way of excluding individuals from the benefit of the good once it comes into existence.
What is the difference between the maximum price a consumer is willing to pay and the actual price?
Consumer Surplus
The three options available to government in order to correct spillover benefits or the underallocation of resources are:
– Subsidies to producers
– Government provision of public goods
– Subsidies to buyers
A __________ ______________, also known as a spillover cost, is a market failure that occurs when a third party to a transaction experiences uncompensated costs.
Negative Externality
the supply curve for any good, private or public, is it’s marginal __________ curve.
cost
A comparison of marginal changes is known as:
A cost-benefit analysis
Characteristic of a private good include:
Rivalry and Excludability
Government intervention may be needed to achieve:
Economic efficiency when externalities affect large numbers of people or when community interests are at stake
The ______ characteristic of a private good is the ability of a seller to prevent people who did not pay for a product from obtaining its benefits
excludability
A positive externality is an uncompensated:
Spillover benefit
A ___________ to a producer is a payment from the government to decrease the producer’s cost in order to encourage more output of a product beneficial to society
Subsidies
Free-rider problem
once a producer has provided a public good, everyone, including nonpayers, can obtain the benefit
When does consumer surplus happen?
when a market does not reflect consumers’ full willingness to pay for a good or service
A supply-side market failure arises in situations in which:
a firm does not have to pay the full cost of producing it’s output
A market failure arises because it is:
not possible for the market to correctly weigh cost and benefits
An _______ causes some of the benefits or costs of a market transaction to be passed on to a third party.
Externality
the ________ curve of positive externalities reflects only the direct private benefit to the individuals who consume the product.
market demand
Deadweight loss
reductions of combined consumer and producer surplus associated with underproduction or overproduction of a product
Externality
A cost or benefit accruing to an individual or group, a third party, that is external to a market transaction
The marginal cost to firms and hence to society _______ as pollution is reduced more and more
rises
Coase Theorem
Government should restrict its involvement to remedying external costs or benefits
Supposed that technology of pollution control equipment improves noticeably. One would expect:
The cost of pollution abatement to fall
The optimal quantity level of abatement to rise
Society’s marginal cost curve to shift rightward
The result of positive externalities is that the market produces too ___________ units of a product that could benefit society because producers ________-allocate resources to that product because some individuals do not consume the product but accrue benefits from others.
few; under
Cost benefit analysis can help the __________ decide on the extent to which a public project should be pursued.
Government
Identify policies for coping with the underallocation of resources associated with positive externalities
– Subsidies to consumers
– government provision
– Subsidies to producers
Supposed that society were to decide that it wanted cleaner air and water because of new information about the adverse health effects of pollution. Then one could expect:
– the optimal quantity level of pollution control to increase
– the marginal benefit curve to shift rightward
What do points on the demand curve represent?
Marginal benefit
Consumer surplus is the area _______ the demand curve and _____________ the market price.
Below; Above
Identify policies for coping with the overallocation of resources caused by negative externalities
– Liability rules and lawsuits
– Direct controls
– Specific taxes
– Markets for externality rights
– Private bargaining
The effects of subsidies on consumers in correcting for positive externalities are:
– The subsidy reduces the price of purchasing the good
– The quantity of the product purchased would rise to the economically optimal output eliminating the under-allocation of resources
– the demand curve would shift out to the right because of an increase in demand.
how does the government provide the optimal quantity of a public good?
It compares the marginal benefit of an added unit of the good against the government’s marginal cost of providing it.
Because the _________ of public goods typically are immediate while the benefits are often accrued over longer time periods, economist convert both costs and benefits to _____________ values of comparison
Cost; Present
1.- Refer to the above supply and demand graph of Product X. What would happen if the government taxed the producers of this product because it has negative externalities in production?
Supply would decrease
There is an adverse selection problem in the market for used cars because:
Owners of poor-quality cars have a strong incentive to sell their cars, while owners of high-quality used cars have more incentive to keep their cars
Refer to the above graph. If the output level increases from Q2 to Q3, then the:
Marginal cost of the product increases while its marginal benefit decreases
4.- It is the custom for paper mills located alongside the Layzee River to discharge waste products into the river. As a result, operators of hydroelectric power-generating plants downstream along the river find that they must clean up the river’s water before it flows through their equipment.
-Refer to the above information. Which of the following policies would be most appropriate for dealing with this problem?
Levy a tax on the producers of paper products and use the tax revenues to clean up the river
Refer to the above supply and demand graph. S1 and D1 represent the current market supply and demand, respectively. S2 and D2 represent the socially optimal supply and demand. One way that the government could shift supply to its socially optimal level is to:
Produce the product
Assume that a government is considering a new social program and may choose to include in this program any number of four progressively larger projects. The marginal cost and the marginal benefits of each of the four projects are given in the table.
Refer to the above table and information. What is the total cost and total benefit of doing projects A, B, and C?
Total cost is $9 billion and total benefit is $12 billion
Answer the question based on the following information. Normal University has found it necessary to institute a crime-control program on its campus to deal with the high costs of theft and vandalism. The university is now considering several alternative levels of crime control. This table shows the expected annual costs and benefits of these alternatives.
Four
E-bay, Amazon and other Internet shopping sites provide “seller ratings” done by previous buyers, in order to help deal with the problem of:
Adverse selection
The franchising of fast-food restaurants would be an example of how a private business:
Overcomes market information problems
Assume that a government is considering a new social program and may choose to include in this program any number of four progressively larger projects. The marginal cost and the marginal benefits of each of the four projects are given in the table.

Picture

Refer to the above table and information. What project should the government select to achieve the maximum net benefit?

C
Answer the question based on the following information. Normal University has found it necessary to institute a crime-control program on its campus to deal with the high costs of theft and vandalism. The university is now considering several alternative levels of crime control. This table shows the expected annual costs and benefits of these alternatives.

Picture

Refer to the above information. If Normal University undertakes program Level Three:

There would be an under-allocation of resources to crime control
The 2010 Health Care Reform Law, also known as “Obamacare”, includes a part known as universal coverage which requires everyone to have health insurance. One reason for this is to address the problem of:
Adverse selection
Assume that a government is considering a new social program and may choose to include in this program any number of four progressively larger projects. The marginal cost and the marginal benefits of each of the four projects are given in the table.

Picture

Refer to the above table and information. What is the net benefit of project D?

$4 billion
Refer to the above supply and demand graph for a public good. Point c on the graph shows where the:
Marginal benefit equals the marginal cost of the public good
Refer to the above graph. If the output level is Q1, then the sum of the consumer and producer surplus is:
0abe
Which of the following antipollution policies is least likely to make use of cost-benefit analysis?
Enacting legislation that bans pollution
Picture

Refer to the above supply and demand graph of Product X. What would happen if the government decided to also start providing Product X in the market?

Price would decrease
Credit bureaus provide credit histories to banks and insurance companies, in order to help deal with the problem of:
Adverse selection
Street entertainers face the free-rider problem when they perform because of the:
Nonexcludability characteristic

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