Module 4 - Efficient and Inefficient Markets

adverse selection

is a situation where imperfect information reduces the quality of goods available in the market

asymmetric information

a situation where either the seller or the buyer has information the other does not have regarding the the item being sold

efficient

Resources are allocated in a way that maximizes the net benefits of all economic activities. The "right" quantity of goods is being produced.

over-production

the market is producing more than the efficient quantity of a good.

under-production

the market is producing less than the efficient quantity of good.

externality

a market exchange that affects a third party who is outside or "external" to the exchange; sometimes called a "spillover"

imperfect information

a situation where the buyer and the seller are uncertain about the qualities of what is being bought and sold

Marginal Benefit (MB)

the additional benefit a consumer enjoys from consuming an extra unit of the good.

Marginal Cost (MC)

the additional cost a producer incurs to make an extra unit of the good

What condition must be met for a market to be efficient?

The market should produce the quantity where MB = MC

market failure

When the market does not produce the efficient quantity of output, MB is not equal to MC.

Moral Hazard

When the act of insuring an event increases the likelihood that the event will happen

price ceiling

maximum legal price that can be charged for a product

How does a price ceiling impact the market?

An effective price ceiling holds the price below the equilibrium price creating a shortage in the market.

How does a price floor impact the market?

An effective price floor keeps the price above the equilibrium price creating a surplus in the market.

What kind of market failures do negative externalities cause?

over-production

What policies are used to correct negative externalities?

taxes and regulations

What policies are used to correct positive externalities?

vouchers, subsidies, and public provision

Is rent control an example of a price ceiling or a price floor?

price ceiling

What kind of price control policy is a minimum wage?

price floor

What is the term for the decrease in product quality that happens when customers have imperfect information about the quality of the goods?

adverse selection

When a positive externality is present will the market be efficient?

No, there will be under-production in the market.

price floor

A legal minimum on the price at which a good can be sold

negative externality

the harm, cost, or inconvenience suffered by a third party because of actions taken by others

In 2007 the US government provided a large bail-out to banks who had made bad mortgage loans. What do we call the problem created when banks expect to be bailed out if the market collapses?

moral hazard

net benefit

the total benefit of an activity minus its opportunity cost

positive externality

a situation where a third party, outside the transaction, benefits from a market transaction by others

shortage

the amount by which the quantity demanded exceeds the quantity supplied at the current price (not enough to go around - people are waiting in line)

social benefits

the dollar value of all benefits of a new product or process invented by a company that can be captured by other firms and by society as a whole

surplus

the amount by which the quantity supplied exceeds the quantity demanded at the current price

What actions can be taken to reduce the inefficiency caused by imperfect information?

guarantees, warranties, and service contracts