Economics Chapter: Market Failures and Surpluses

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Questions and Answers

What is market failure?

Market failure occurs whenever competitive markets do not allocate resources in the most economically desirable way.

What two conditions must hold for a competitive market to produce efficient outcomes?

Supply curves must reflect all costs of production, and demand curves must reflect consumers' full willingness to pay.

What is producer surplus?

Producer surplus is the difference between the minimum prices producers are willing to accept for a product and the higher equilibrium price.

What consumer surplus does Jennifer experience?

Jennifer experiences a consumer surplus of $9. Signup and view all the answers

How is consumer surplus graphically represented if the supply and demand curves are linear?

Consumer surplus is measured as the triangle under the demand curve and above the actual price. Signup and view all the answers

What occurs when there is a positive externality?

A positive externality occurs when the benefits associated with a product exceed those accruing to people who consume it. Signup and view all the answers

What happens in a negative externality?

A negative externality occurs when the total cost of producing a good exceeds the costs borne by the producer. Signup and view all the answers

What are Pigovian taxes used for?

Pigovian taxes are used to correct negative externalities. Signup and view all the answers

Which of the following is an example of a negative externality?

Falling property values in a neighborhood where a disreputable nightclub is operating Signup and view all the answers

What is a result of asymmetric information between buyers and sellers?

Markets can produce inefficient outcomes. Signup and view all the answers

Why do sellers opt out of markets with inadequate buyer information?

Sellers opt out because inadequate information allows some buyers to impose high costs on them. Signup and view all the answers

What occurs when asymmetric information is present in a market transaction?

Asymmetric information occurs when there is unequal knowledge possessed by the buyer and seller. Signup and view all the answers

Which of the following would be an example of a moral hazard problem?

A person who purchases auto insurance and then drives more recklessly Signup and view all the answers

What is the significance of the adverse selection problem in the used car market?

In the market for used cars, owners of poor-quality cars have a strong incentive to sell, while owners of high-quality used cars have more incentive to keep their cars. Signup and view all the answers

What is the Coase theorem?

The Coase theorem suggests that some externalities can be resolved through private negotiations among the affected parties. Signup and view all the answers

What is an externality?

An externality is when some of the costs or benefits of a good or service are passed onto or 'spilled over to' someone other than the immediate buyer or seller. Signup and view all the answers

Give an example of a negative externality.

Breathing polluted air. Signup and view all the answers

Give an example of a positive externality.

People living near Disneyland who enjoy the park's fireworks display even though they did not purchase admission to the park. Signup and view all the answers

What is a negative externality?

A cost imposed without compensation on third parties by the production or consumption of sellers or buyers. Signup and view all the answers

What is a positive externality?

A situation where people who are not directly involved in a market transaction receive benefits from that transaction without having to pay for them. Signup and view all the answers

What are positive externalities also called?

Free riders. Signup and view all the answers

Another example of a positive externality is _______.

vaccinations Signup and view all the answers

What is asymmetric information?

Asymmetric information is a situation where one party to a market transaction has more information about a product or service than the other. Signup and view all the answers

What is consumer surplus?

The difference between the maximum price a consumer is willing to pay for a product and the actual price that they do pay. Signup and view all the answers

What is efficiency loss?

Efficiency loss refers to reductions in combined consumer and producer surplus caused by an under-allocation or overallocation of resources to the production of a good or service. Signup and view all the answers

Study Notes

Market Failure and Efficiency

Market failure occurs when competitive markets fail to allocate resources efficiently.
For a competitive market to produce efficient outcomes, supply curves must reflect all production costs, and demand curves must show consumers' full willingness to pay.

Surpluses in Economics

Producer surplus is the difference between the prices producers are willing to accept and the higher equilibrium price.
Consumer surplus is determined by the difference between the maximum price a consumer is willing to pay and the actual price paid.
Example: Jennifer buys jewelry for $33 while willing to pay $42, resulting in a consumer surplus of $9; the seller Nathan has a producer surplus of $3 if his minimum price is $30.

Graphical Representation

When supply and demand curves are linear, consumer surplus is illustrated as the triangle area under the demand curve and above the actual price.

Externalities

Positive externalities arise when product benefits exceed those received by consumers.
Negative externalities occur when the total costs of production surpass those borne by the producer.
Pigovian taxes are utilized to address negative externalities.
Example of negative externality: A nightclub lowering property values in its vicinity.

Asymmetric Information

Asymmetric information leads to inefficient market outcomes when buyers and sellers have unequal knowledge.
Sellers may withdraw from markets if they lack adequate buyer information, risking high costs.
This situation can also lead to moral hazard where individuals change their behavior after acquiring insurance, exemplified by reckless driving post-auto insurance purchase.
Adverse selection is seen in used car markets where low-quality car owners are incentivized to sell, while high-quality car owners prefer to retain their vehicles.

Coase Theorem

The Coase theorem suggests that some externalities can be resolved through private negotiations among affected parties.

Understanding Externalities

An externality refers to costs or benefits of a good that affect third parties beyond the immediate buyer or seller.
Negative externality example: Breathing polluted air.
Positive externality example: People enjoying fireworks from Disneyland without paying for admission.

Characteristics of Externalities

Negative externalities impose unpaid costs on third parties from production or consumption activities.
Positive externalities benefit those not directly involved in transactions, often termed "free riders," as in the case of vaccinations.

Consequences of Asymmetric Information

Asymmetric information leads to misallocation of resources, either under- or over-allocating based on one party having more information than the other.

Efficiency Loss

Efficiency loss, also called deadweight loss, refers to the reduction in combined consumer and producer surplus due to suboptimal resource allocation.

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Description

Explore the concepts of market failures and efficiency in this quiz. Understand how producer and consumer surpluses are calculated, along with their graphical representation. Dive deep into the implications of externalities in economic contexts.