Market Failure and the Role of Government

External Cost

An uncompensated cost that an individual or firm imposes on others

External Benefit

A benefit that an individual or firm confirs on others without recieving compensation

Externalities

a side effect of an action that affects a third party other than the buyer or seller

Example of a negative externality

pollution

Example of a positive externality

when a homeowner’s mosquito treatment repels mosquitos from the neighborhood

Coase Theorem

the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own

Internalize the externalities

when individuals take external costs or benefits into account

Pigouvian subsidy

a payment designed to encourage activities that yield external benefits

marginal private benefit

The benefit from an additional unit of a good or service that the consumer of that good or service receives. (Demand Curve)

marginal social benefit

the additional gain to society as a whole from an additional unit

Rival in consumption

the property of a good whereby one person's use diminishes other people's use

excludable

the property of a good whereby a person can be prevented from using it

public good

a shared good or service for which it would be impractical to make consumers pay individually and to exclude nonpayers. Non-Rival, Non-Excludable

free-rider

a person who receives the benefit of a good but avoids paying for it

common resource

a good that is rival but not excludable

natural monopoly

AKA "Artificially Scarce." Excludable but not rival in consumption

Private Good Example

food

Public Good Example

Tornado Siren

Natural Monopoly Example

Cable television

common resource example

salmon in the open sea

poverty threshold

the annual income below which a family is officially considered poor

poverty rate

the percentage of people who live in households with income below the official poverty line

Lorenz Curve

Graph showing how much the actual distribution of income differs from an equal distribution

Gini Coefficent

A measure of income inequality within a population, ranging from zero for complete equality, to one if one person has all the income. (A/A+B When A is the area between the curve of equality and the Lorenz Curve.)

in-kind benefit

a benefit given in the form of goods or services

negative income tax

a tax system that collects revenue from high-income households and gives subsidies to low-income households

information asymmetry

situation in which one party is more informed than another because of the possession of private information

moral hazard

the actions people take after they have entered into a transaction that make the other party to the transaction worse off

adverse selection

a market situation where buyers and sellers have different information. The result is the unequal distribution of benefits to both parties, with the party having the key information benefiting more.