Chapter 9 - Public goods + HL Market failure

What are public goods?

Goods that would not be provided in the free market. Non excludable and non rivalrous. Since they are goods that are a benefit to society, the lack of them is considered a market failure

What are private goods?

Goods are able to consumed once by an individual and cannot be used by someone else so it has excludability and its rivalrous.

What is non excludable?

Provision of G or S, that cannot be provided to just one consumer without allowing others to consume it as well

What is non rivalrous?

Individual’s consumption of a good does not prevent others from gaining some utility from consuming it.

What is the free rider problem?

When an individual cannot be excluded from consuming a good so they have no incentive to pay for it.

What are the 2 ways that the government can reduce this market faikure and increase supply of public goods?

Direct provision

Public private partnership

How does direct provision work in this place?

Provide good themselves. This is normally the case with flood barriers, national defence, street lights etc.

How does tax paying help increase public goods?

The use of taxpayers money to fund the provision spreads the cost over a large number of people

How else can government reduce this market failure?

Might work with private sector, providing the financing for the establishment of the good, and then allowing them to run it. This is called a public private partnership

What is asymmetric information?

A situation where there is an inbalnce of information between 2 parties

Adverse selection

When better informed party uses an asymmetric balance of information to take advantage of another party before an exchange or agreement takes place

Give an example of adverse selection

For example, an insurance company charges everyone £1,000 for health insurance. Healthy consumers may decide not to buy it because they expect low medical costs, while unhealthy/high-risk consumers are more likely to buy it because they expect high medical costs. The consumer knows more about their health risk than the insurance company, causing adverse selection.

Why does adverse selection lead to make failures for car insurance?

Consumers have more information compared to producers, as they know how risky they are.

Producers unaware of the risk so they charge lower premium prices to risker drivers.

Insurance providers are more likely to pay out for these high risk drivers which increases costs.

raises prices for all

Low risk drivers are unlikely to pay for insurance

Under consumed in the free market

How is the imbalance in asymmetric information balanced?

Screening → asking Qs

How can adverse selection happen in terms of sellers having more information than buyers?

Uniformed consumers aren’t able to tell difference between high and low quality cars.

Used car sellers charge average price

Those who get avg price for a dingy are happy because they have received more than market value

Those who have a good quality car but have to sell for market average, so they make a loss for the real value of their car.

Problem is if they set a higher price no one will buy it

No market for a good therefore a market failure

What is signalling?

Party with more information can provide reliable information to party with less info. Use car sellers → provide accurate signals consumers such as guarantees and warrantees.

What is moral hazard?

Occurs after a deal has been made between 2 parties with asymmetric information and one party changes their behaviour as a result

Why does moral hazard lead to market failure in the case of car insurance?

• A person buys health insurance.

• Before insurance, they may exercise, eat healthily and avoid risky behaviour.

• After getting insurance, they may take fewer precautions because → insurance company will cover their medical costs.

• Higher healthcare costs and more healthcare being consumed than would otherwise be necessary.

• The insurance company may respond by raising premiums, which can discourage lower-risk people from buying insurance.

• This can result in an inefficient allocation of resources → market failure.