Chapter 4: Market Failures Caused by Externalities and Asymmetric Information

efficiency losses

reductions in combined consumer surplus caused by an under allocation or overallocation of resources to the production of a good or service

efficiency losses

consumers’ maximum willingness to pay exceeds producers’ minimum acceptable price

efficiency losses

caused by underproduction

efficiency losses

not enough is made for the amount of people in the market

externality

when some of the costs or benefits of a good or service are passed onto or “spill over to” someone other than the immediate buyer or seller

externality

reduce the marginal costs of producers from what they would be if they ate the costs themselves

negative externality

when producers or suppliers impose costs on third parties who are not directly involved in a market transaction

negative externality

results in a deadweight efficiency loss

positive externality

when people who are not directly involved in a market transaction receive benefits from the market transaction without having to pay for them

positive externality

market curved doesn’t include the willingness of people who receive the positive eternality to pay

positive externality

shifts market curve to the left(below) of where they would be if all things were considered

positive externality

market doesn’t produce all units where benefits exceed costs

direct controls

force the offending firms to incur the actual costs of the offending activity

direct controls

most direct way at reducing negative externalities

pigovian taxes

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

pigovian taxes

causes manufacturers to decide whether to pay off the tax or expend additional funds to purchase or develop substitute products

taxes

payments to the government that increases producers’ cost

subsidies

payments from the government that decreases producers’ cost

asymmetric information

a situation where one party to a market transaction has more information about a product or service than the other

asymmetric information

may be the result in under or over allocation of resources

asymmetric information

may lead to inefficient allocation of scarce resources

private information

facts known by one party to a market transaction but hidden from others

moral hazard problem

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

moral hazard problem

arises when a person behaves more recklessly after obtaining a contract that shifts the costs of bad outcomes onto another party

moral hazard problem

reduces the likelihood that insurance companies can profit with some types of insurance

moral hazard problem

happens when medical malpractice insurance may increase the amount of malpractice

moral hazard problem

happens when unemployment compensation may lead some workers to shrink

moral hazard problem

happens when guaranteed contracts for professional athletes may reduce the quality of their performance

adverse selection problem

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

adverse selection problems

happens when the people who are most likely to need insurance payouts are the people most likely to buy insurance

adverse selection problem

tends to eliminate the unbiased pooling of low and high risks

adverse selection problem

can be solved by insurance companies charging different rate to hgh risk and low risk customers

adverse selection problem

can be solved by government rivaling it by requiring that every potential customer purchase insurance

adverse selection problem

when there isn’t really anything a private insurance company can do to prevent this when buyers hold tightly to their private information