Knowt
6.1: Market Economies
The “invisible Hand” Of Free Markets
Businesses Have The Incentive To Meet Societal Demands To Earn Profit
Information Asymmetry: A Situation In Which One Party Is More Informed Than Another Because Of The Possession Of Private Information
Adverse Selection: Parties Involved In A Transaction Fear That There Is Negative Information About The Other Party, Goods, Or Services That They May Not Know
Example Of Information Asymmetry
Moral Hazard: A Market Failure That Results From A Change In The Buyer’s Behavior After A Purchase As A Result Of The Buyer’s Belief That Losses Will Be Passed Onto The Seller
Market Failure
Market Failure: A Situation In Which The Free-market System Fails To Satisfy Society’s Wants
Ie. When The Invisible Hand Doesn’t Work
Private Markets Do Not Efficiently Bring About The Allocation Of Resources
Results In The Government Being Called Upon To Attempt To Satisfy Society’s Demands
The Four Market Failures
Public Goods
Externalities (third-person Side Effects)
Imperfect Competition (monopolies)
Unequal Distribution Of Income
Supply And Demand
Demand = marginal Social Benefit Of A Good And Its Usefulness And Society
Supply = marginal Social Cost Of Providing Each Additional Quantity
Socially Optimal Quantity: MSB=MSC
Externalities
Externality: A Third-person Side Effect
External Benefits/external Costs To Someone Other Than The Original Decision Maker
Externalities As Market Failures
The Free Market Fails To Include External Costs Or External Benefits
With No Government Involvement, There Would Be Too Much Of Some Goods And Too Little Of Others
Eg. Smoking Cigarettes
The Free Market Assumes That The Cost Of Smoking Is Fully Paid By People Who Smoke
The Government Recognizes External Costs And Makes Policies To Limit Smoking
Negative Externalities
Negative Externality: A Situation That Results In A Cost For A Different Person Other Than The Original Decision Maker
The Costs “spill Over” To Other People In Society
Positive Externalities
Positive Externality: A Situation That Results In A Benefit For Someone Other Than The Original Decision Maker
The Benefits “spill Over” To Other People Or Society
Eg. Flu Vaccines
6.1: Market Economies
The “invisible Hand” Of Free Markets
Businesses Have The Incentive To Meet Societal Demands To Earn Profit
Information Asymmetry: A Situation In Which One Party Is More Informed Than Another Because Of The Possession Of Private Information
Adverse Selection: Parties Involved In A Transaction Fear That There Is Negative Information About The Other Party, Goods, Or Services That They May Not Know
Example Of Information Asymmetry
Moral Hazard: A Market Failure That Results From A Change In The Buyer’s Behavior After A Purchase As A Result Of The Buyer’s Belief That Losses Will Be Passed Onto The Seller
Market Failure
Market Failure: A Situation In Which The Free-market System Fails To Satisfy Society’s Wants
Ie. When The Invisible Hand Doesn’t Work
Private Markets Do Not Efficiently Bring About The Allocation Of Resources
Results In The Government Being Called Upon To Attempt To Satisfy Society’s Demands
The Four Market Failures
Public Goods
Externalities (third-person Side Effects)
Imperfect Competition (monopolies)
Unequal Distribution Of Income
Supply And Demand
Demand = marginal Social Benefit Of A Good And Its Usefulness And Society
Supply = marginal Social Cost Of Providing Each Additional Quantity
Socially Optimal Quantity: MSB=MSC
Externalities
Externality: A Third-person Side Effect
External Benefits/external Costs To Someone Other Than The Original Decision Maker
Externalities As Market Failures
The Free Market Fails To Include External Costs Or External Benefits
With No Government Involvement, There Would Be Too Much Of Some Goods And Too Little Of Others
Eg. Smoking Cigarettes
The Free Market Assumes That The Cost Of Smoking Is Fully Paid By People Who Smoke
The Government Recognizes External Costs And Makes Policies To Limit Smoking
Negative Externalities
Negative Externality: A Situation That Results In A Cost For A Different Person Other Than The Original Decision Maker
The Costs “spill Over” To Other People In Society
Positive Externalities
Positive Externality: A Situation That Results In A Benefit For Someone Other Than The Original Decision Maker
The Benefits “spill Over” To Other People Or Society
Eg. Flu Vaccines