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Questions and Answers
What is the term for a beneficial effect on a third party who is not directly involved in a transaction?
What is the term for a beneficial effect on a third party who is not directly involved in a transaction?
Which of the following is a characteristic of a public good?
Which of the following is a characteristic of a public good?
What is a consequence of market failure due to externalities?
What is a consequence of market failure due to externalities?
Which of the following is an example of a public good?
Which of the following is an example of a public good?
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What is a consequence of market failure due to public goods?
What is a consequence of market failure due to public goods?
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Why do public goods often suffer from underproduction or lack of provision?
Why do public goods often suffer from underproduction or lack of provision?
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Which of the following types of inflation is caused by an increase in production costs?
Which of the following types of inflation is caused by an increase in production costs?
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What is the primary objective of inflation targeting by central banks?
What is the primary objective of inflation targeting by central banks?
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What is the primary cause of hyperinflation?
What is the primary cause of hyperinflation?
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What is a characteristic of deflation?
What is a characteristic of deflation?
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What is an effect of inflation on fixed-income earners?
What is an effect of inflation on fixed-income earners?
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What is a fiscal policy tool used to combat inflation?
What is a fiscal policy tool used to combat inflation?
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What is an effect of hyperinflation?
What is an effect of hyperinflation?
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What is a characteristic of monetary policy in controlling inflation?
What is a characteristic of monetary policy in controlling inflation?
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Study Notes
Market Failure
Externalities
- Definition: Externalities occur when a transaction between two parties affects a third party who is not directly involved in the transaction.
- Types:
- Positive externality: A beneficial effect on a third party, e.g., a beekeeper's bees pollinate nearby crops.
- Negative externality: A harmful effect on a third party, e.g., pollution from a factory affecting neighboring residents.
- Examples:
- Environmental pollution (air, water, noise)
- Second-hand smoke
- Noise pollution from airports
- Consequences:
- Overproduction or underproduction of goods and services
- Inefficient allocation of resources
- Social welfare loss
Public Goods
- Definition: Goods and services that are non-rivalrous (can be consumed by multiple people without reducing their quantity) and non-excludable (difficult or impossible to exclude people from consuming).
- Characteristics:
- Non-rivalry: Multiple people can consume without reducing the quantity.
- Non-excludability: Difficult or impossible to exclude people from consuming.
- Examples:
- National defense
- Public parks
- Street lighting
- Consequences:
- Underproduction or lack of provision due to free-rider problem
- Inefficient allocation of resources
- Social welfare loss
Consequences of Market Failure
- Inefficient allocation of resources
- Social welfare loss
- Overproduction or underproduction of goods and services
- Inequitable distribution of goods and services
- Reduced economic efficiency
- Potential for government intervention to correct the market failure
Market Failure
Externalities
- Externalities occur when a transaction affects a third party who is not directly involved in the transaction.
- There are two types of externalities:
- Positive externality: a beneficial effect on a third party, e.g., a beekeeper's bees pollinate nearby crops.
- Negative externality: a harmful effect on a third party, e.g., pollution from a factory affecting neighboring residents.
- Examples of externalities include:
- Environmental pollution (air, water, noise)
- Second-hand smoke
- Noise pollution from airports
- Consequences of externalities include:
- Overproduction or underproduction of goods and services
- Inefficient allocation of resources
- Social welfare loss
Public Goods
- Public goods are non-rivalrous and non-excludable.
- Non-rivalry means multiple people can consume without reducing the quantity.
- Non-excludability means it's difficult or impossible to exclude people from consuming.
- Examples of public goods include:
- National defense
- Public parks
- Street lighting
- Consequences of public goods include:
- Underproduction or lack of provision due to the free-rider problem
- Inefficient allocation of resources
- Social welfare loss
Consequences of Market Failure
- Market failure leads to:
- Inefficient allocation of resources
- Social welfare loss
- Overproduction or underproduction of goods and services
- Inequitable distribution of goods and services
- Reduced economic efficiency
- Government intervention may be necessary to correct market failure.
Inflation
Causes of Inflation
- Excessive aggregate demand leads to higher prices due to demand-pull inflation
- Increase in production costs, such as higher wages or raw materials, leads to cost-push inflation
- Excessive growth in money supply leads to inflation through monetary policy
- Supply shocks, like natural disasters or global pandemics, disrupt supply chains and lead to higher prices
Effects of Inflation
- Inflation redistributes wealth from fixed-income earners to borrowers
- Inflation creates uncertainty, making it difficult for businesses to make long-term plans
- Inflation exacerbates income inequality, benefiting those who own assets that increase in value
Monetary Policy and Inflation
- Central banks use monetary policy tools to control inflation
- Inflation targeting involves setting an inflation target and adjusting monetary policy to achieve it
Hyperinflation
- Extreme inflation rates exceed 50% per month, rendering the currency nearly worthless
- Causes of hyperinflation include excessive money printing, fiscal policy mistakes, and supply shocks
- Hyperinflation leads to currency devaluation, economic collapse, and loss of savings
Deflation
- Deflation is a sustained decrease in the general price level of goods and services over time
- Causes of deflation include decreased aggregate demand, improvement in productivity, and increased productivity
- Effects of deflation include increased debt burden, reduced spending and investment, and potential for deflationary spiral
Fiscal Policy and Inflation
- Increased government spending can stimulate economic growth but may lead to inflation if excessive
- Taxation can reduce aggregate demand, helping to combat inflation
- Fiscal discipline helps maintain low and stable inflation through a sustainable fiscal stance
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Description
Learn about externalities, a type of market failure that occurs when a transaction affects a third party. Understand the different types of externalities and their examples.
