Market Failures Caused by Externalities and Asymmetric Information

This set of flashcards covers key vocabulary and concepts related to market failures caused by externalities and asymmetric information, as discussed in the lecture notes.

Market Failures

Situations in which markets fail to produce the right amount of the product, leading to inefficiencies.

Consumer Surplus

The difference between what a consumer is willing to pay for a good and what the consumer actually pays; represents extra benefit.

Producer Surplus

The difference between the actual price a producer receives and the minimum price they would accept; represents extra benefit from higher prices.

Externality

A cost or benefit accruing to a third party external to the market transaction.

Negative Externalities

Costs that result from a market transaction that affect third parties negatively, often leading to overproduction.

Positive Externalities

Benefits that result from a market transaction that affect third parties positively, often leading to underproduction.

Pigovian Tax

A tax imposed to correct the negative externalities by aligning private costs with social costs.

Subsidy

Financial assistance given by the government to encourage the production of positive externalities.

Coase Theorem

A theory suggesting that private sector bargaining can solve externality problems without government intervention if property rights are clear.

Asymmetric Information

Occurs when one party to a transaction has private information that is not readily available to the other party, leading to inefficiencies.

Moral Hazard Problem

A situation where one party to a transaction can take risks because they do not bear the full consequences of that risk.

Adverse Selection Problem

A situation where one party in a transaction holds information not available to the other party, leading to market inefficiencies.

Cap and Trade

An environmental policy that sets a limit on emissions, allowing companies to buy and sell allowances to pollute.