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Questions and Answers
Which circumstance indicates that a market is inefficient due to imperfect competition?
What characterizes public goods, making them unlikely to be produced without intervention?
Which type of externality leads to markets producing a larger quantity than is socially desirable?
What is the primary problem caused by asymmetric information in market transactions?
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Which of the following actions can help equalize information in a market transaction affected by asymmetric information?
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What is the relationship defined by the equation: Social Cost/Benefit = Private Cost/Benefit + Externality Cost/Benefit?
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Which of the following describes the free rider problem associated with public goods?
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How do positive externalities influence market production levels?
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What is 'adverse selection' in the context of asymmetric information?
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Study Notes
Market Failures
- Market failures occur when a free market leads to an inefficient equilibrium.
- Market failures are the main reason for government intervention.
- Sources of market failure include imperfect competition, equity concerns, taxes, and public goods, and externalities.
Imperfect Competition
- Producers may set prices above marginal costs to take advantage of market power, leading to reduced output compared to an efficient market.
Equity, Taxes, and Public Goods
- Taxes create a difference between the price buyers pay and the price sellers receive.
- Public goods are non-rival (one person's use doesn't diminish another's) and non-excludable (difficult to prevent use by non-payers).
- Public goods are often underprovided by the market and require government intervention (or private solutions/cooperation).
Externalities
- Externalities are when one person's actions affect others, either positively or negatively, but those affected aren't compensated.
- Examples include pollution, noise, congestion, and education.
- No market exists for externalities, so the marginal social cost/benefit isn't equal to the private cost/benefit.
- Externalities can be:
- Negative production (pollution)
- Negative consumption (secondhand smoke)
- Positive production (education)
- Positive consumption (vaccination)
- Negative externalities lead to overproduction, and positive externalities lead to underproduction.
Asymmetric Information
- Asymmetric information exists when one party in a transaction has more information than the other.
- This can lead to opportunistic behavior, like in insurance markets where those with greater risks are more inclined to purchase coverage.
- Types include:
- Adverse selection (hidden information)
- Moral hazard (hidden actions)
- Solutions involve things like screening, signaling, and third-party comparisons and regulations.
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Description
This quiz explores the concept of market failures in economics, including their causes such as imperfect competition, equity concerns, taxes, public goods, and externalities. Understand the implications of these failures and the need for government intervention in the market.
