AP Micro Chapters 4-5

Market Failure

Inability of a market to bring about the allocation of resources that best satisfies the wants of society

Consumer Surplus

Difference between the maximum price a consumer is willing to pay for an additional unit of product and its market price. Triangle below the demand curve and above the market price.

Producer Surplus

Difference between actual price a producer receives and the minimum acceptable price. Triangle above supply curve and below market price.

Productive efficiency

production of a good in least costly way

Allocative efficiency

apportionment of resources among firms and industries to obtain the production of the products most wanted by society

Efficiency Losses (Deadweight Losses)

Reductions in combined consumer and producer surplus caused by an underallocation or overallocation of resources to the production of product

Direct Controls

Government politics that directly constrain activities that generate negative externalities

Pigovian tax

Tax or charge levied on production of a product that generates negative externalities

Government Provision

Government provides good because positive externalities are extremely high

Optimal reduction of an externality

the reduction of a negative externality to the level at which the marginal benefit of reduction = marginal cost of reduction

Asymmetric information

when one party to a market transaction possesses substantially more information than the other party

Moral hazard problem

possibility that individuals or institutions will behave more recklessly after they obtain insurance or similar contracts that shift financial burden of bad outcome onto others

Adverse selection problem

Problem arising when information known to one party to a contract or agreement is not known to the other party, causing latter to incur major costs

Qualification

Helps private sector overcome asymmetric information problem without gov intervention

Demand-side market failure

Underallocations of resources that occur when private demand curves understate consumers’ full willingness to pay for a good or service

Rivalry

when one person consumes a product it is not available for another person

Excludability

sellers can prevent people who do not pay for a product from obtaining its benefits

Quasi-Public Good

Good or service to which excludability could apply but that has such a large positive externality that government sponsors its production to prevent an under allocation of resources

Principal-agent problem

when agents pursue their own objectives to the detriment of the principals’ (stockholders) goals

Special-interest effect

Any political outcome in which a small group gains substantially at the expense of much larger number of people who each individually suffers a small loss

Rent-Seeking Behavior

attempts to use political influence to receive payments in excess of the minimum amount they would normally be willing to accept to provide a particular good or service

Regulatory capture

Occurs when government regulatory agency ends up being controlled by industry that it is supposed to be regulating

Political corruption

unlawful misdirection of government resources or when officials abuse their entrusted powers for personal gain

Negative externalities graph

• Second supply line showing overproduction

• Overallocation is area of triangle to the right of demand line

Positive externalities graph

• second demand line showing underproduction and more demand

• under allocation is triangle to the left of supply line