positive externalities, public goods, asymmetric info, inability to achieve equity

positive production externalities

• external benefits created by producers

• eg: R&D efforts that lead to the spreading of productivity improvements

positive production externalities graph

• when MSC < MPC

• Qm < Qopt and MSB > MSC so the market is under-allocating resources and not enough is being produced

ways to correct PPE

• direct govt provision: engaging in R&D or innovation in public companies or offer training to workers. can be done using funds from taxes

• subsidies: providing a subsidy equal to the external benefit to reduce costs of production and increase provision

positive consumption externalities

• the external benefits created by consumers

• eg: consumption of education spills over into society in the form of higher productivity, lower unemployment and higher rate of economic growth.

positive consumption externalities graph

• when MSB > MPB

• Qm < Qopt and MSB > MSC so the market is under-allocating resources and not enough is consumed

ways to correct PCE (increase demand)

• govt regulation: make certain services compulsory

• education and awareness creation: inform consumers of benefits

• nudges: Create incentives to stimulate adoption of goods/services that increase spillover benefits

INCREASE IN PRICE

ways to correct PCE (increase supply)

• direct govt provision: provide merit goods to increase supply and reduce the amount that is under-allocated

• subsidies: increases supply of the good/service, reducing the under allocation

DECREASE IN PRICE

consequences of legislation, education and awareness creation

• limitations with regards to calculating the size of the external benefit

• increase price for consumers, making some g/s unaffordable

• best used in conjunction with direct provision and subsidies

consequences of direct govt provision and subsidies

• effective in increasing the quantity of a g/s + lowering price for consumers

• opportunity cost

• difficult to measure size of external benefit

public goods

goods that are non-excludable and non rivalrous:

• non-excludable: not possible to exclude someone from using the good

• non-rivalrous: the consumption by one person does not reduce consumption by someone else

the free rider problem

when people can enjoy the use of a good without paying for it.

market failure of public goods

• form of market failure because private firms don’t produce them, so are underproduced

• market fails to allocate resources to their production

consequences of direct government provision

• due to opportunity cost there are issues in determining which and how much of these public goods to provide

• Economic criteria should be used but it is difficult to estimate expected benefits- no market price for public goods

• Votes, surveys are used instead to estimate the “cost-benefit”. Problem- people will exaggerate the need or value

consequences of contracting out to private sector

• competitive tendering- lowest cost provider will be selected

• better quality control

• access to broader range of skills/technology than the govt

• private firm may be more flexible/innovative

• govt becomes less accountable

• govt loses control

• cost may be greater

• monitoring adds to costs

asymmetric information

• occurs when there is missing information and buyers and sellers don’t have equal access to information

adverse selection (seller knows more)

• weary consumers are often aware or skeptical which means they will be more cautious

• results in less demand, thus less production (underallocation)

• if consumers are unaware and trust the seller there will be overconsumption (overallocation)

government responses to adverse selection

• regulation: pass laws that ensure quality standards and safety features that must be maintained

  • time-consuming

• provision of info: govt provides or forces producers to provide info

  • time-consuming, opportunity cost, info may not be entirely accurate

• licensure: govts can require producers to be licensed to practice, sell goods, offer services

private responses to adverse selection

• screening: used by the buyer so buyers can get more info on their purchases. information about sellers can be posted online

• signalling: used by the sellers so they can convince buyers that the g/s can be trusted. may provide warranties or return policies that increase trust

adverse selection (buyer knows more)

• often rises when buying health insurance

• results in less supply since the seller is weary of information being withheld so less is offered which makes it more expensive and less people take it up (underallocation).

moral hazard

• happen when one party changes their behavior after obtaining an insurance

• responses: making the insurance taker pay for part of the costs, regulation and monitoring by the govt

why the free market results in income inequalities

• arise from the difference in education, skills and general ownership of assets and wealth.

• distribution of factors such as land, capital and entrepreneurial abilities is generally unequal in a society based on a market-determined distribution.

• so, income distribution will be unequal and it would be up to the government to redistribute these so that the  outcome is fairer

inequality in wealth

• refers to the money or things of value that people own. eg: stocks, land, houses, paintings or jewelry.

• income- possibility of saving- rise to creation of wealth

• high income, low wealth- spend a lot

• low income, high wealth- inherited assets