EC1450 Principles of Microeconomics - Externalities and Information

Flashcards about Microeconomics - Externalities, Property Rights, and Information

What is the Tragedy of the Commons?

Problem with shared resources where individuals acting in their own self-interest deplete the resource, leading to inefficient outcomes.

What is the incentive for each farmer in the public pasture example?

Each farmer has the incentive to add more cattle to increase profit, but the pasture has a limited capacity to support grazing.

What is the most likely outcome if farmers keep adding cattle to a shared pasture?

The pasture is degraded and eventually can't support any cattle.

How can the Tragedy of the Commons be solved?

Private property rights can help solve the Tragedy of the Commons by aligning incentives.

Define Positional Externalities

When payoffs depend on relative performance; an increase in one person’s performance reduces the expected reward of another.

Give some examples of Positional Externalities

Grading on a curve, competitive sports, and loud parties.

What do Positional externalities incentivize?

Escalating series of mutually offsetting investments which produce inefficient outcomes.

In the football players taking anabolic steroids example, what is the dominant strategy?

Steroids

In the Smith and Jones example, what is the formula for utility?

U = X + R + P, where X is weekly income, R is satisfaction from relative position, and P is satisfaction with savings level.

In the Smith and Jones example, what is the solution to the game?

Both choose low savings

Is 'keeping up with the Joneses' efficient?

No, it's not efficient.

What assumption about information is made regarding perfect competition?

In perfectly competitive markets it is assumed that all parties have full information

Optimal Amount of Information

Acquire information up to the point where Marginal Cost = Marginal Benefit (MC = MB)

Define Expected Value

A predicted value of a variable, calculated as the sum of all possible values the variable can take, each multiplied by the probability of their occurrence.

What is a fair gamble?

A fair gamble has an expected value of zero.

Define Risk Aversion

The risk averse person is someone who would refuse a fair gamble

Define Risk Neutral

The risk neutral person is someone who would accept any gamble that is fair (or better)

Define Risk Lover

The risk lover would accept a gamble that is worse than fair