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Define Market Failure. |
Market failure is a situation in which the allocation of goods and services is not efficient. |
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State the two types of Market Failures and give an example of each one. |
1. Demand-side market failures happen when demand curves do not reflect consumers’ full willingness to pay for a good or service. 2. Supply-side market failures occur when supply curves do not reflect the full cost of producing a good or service. |
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Explain "efficiently functioning markets". |
… |
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Define and illustrate consumer surplus. |
It is defined as the difference between the maximum price a consumer is (or consumers are) willing to pay for a product and the actual price that they do pay. Below demand curve. |
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Define and illustrate producer surplus. |
It is the difference between the actual price a producer receives and the minimum acceptable price that a consumer would have to pay the producer to make a particular unit of output available. Above supply curve. |
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In terms of consumer and producer surplus, when is economic efficiency achieved? |
1. MB = MC 2. Maximum willingness to pay = minimum acceptable price. 3. Total surplus (= sum of consumer and producer surplus) is at a maximum. |
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Explain and illustrate why under-production or over-production of a good results in efficiency losses (deadweight loss). |
Quantities less than or greater than the allocatively efficient level of output create efficiency losses. |
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What is the difference between private and public goods? |
PRIVATE GOOD: A good, or service that is individually consumed and that can be profitably provided by privately owned firms because they can exclude nonpayers from receiving the benefits. PUBLIC GOOD: A good or service that is characterized by nonrivalry and nonexcludability. These characteristics typically imply that no private firm can break even when attempting to provide such products. |
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How does the market demand curve for a public good differ from the market demand curve for a private good? |
The market demand curve for a public good will not slope downwards because people will not bear any marginal cost for it. |
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How do quasi-public goods differ from pure public goods? Give examples of both types. |
QUASI: Government provides goods and services that could be produced and delivered in such a way that exclusion would be possible. Ex: education, highways, fire protection, libraries, preventive medicine, and sewage disposal. PURE PUBLIC: A good or service that is characterized by nonrivalry and nonexcludability. These characteristics typically imply that no private firm can break even when attempting to provide such products. Ex: National Defense and street lighting. |
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What is the re-allocation process? |
The government uses taxes to reallocate resources from the production of private goods to the production of public and quasi-public goods. |
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Define negative externality. Give an example. |
Negative externalities cause supply-side market failures. These failures happen because producers do not take into account the costs that their negative externalities impose on others. This failure to account for all production costs causes firms’ supply curves to shift to the right of (or below) where they would be if firms properly accounted for all costs. Ex: Breathing polluted air. |
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Define positive externality. Give an example. |
Positive externalities cause demand-side market failures. These failures happen because market demand curves in such cases fail to include the willingness to pay of the third parties who receive the external benefits caused by the positive externality. This failure to account for all benefits shifts market demand curves to the left of (or below) where they would be if they included all benefits and the willingness to pay of both the third parties as well as the primary beneficiaries. Ex: Vaccinations. |
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What methods are used to deal with negative externalities? |
Government can use direct controls and taxes to counter negative externalities. Direct controls: legislation limiting activity producing negative externalities. Specific taxes: government levies taxes or specific charges on the related goods. |
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What methods are used to deal with positive externalities? |
Government may provide subsidies or public goods to deal with positive externalities. Subsidy: is a tax in reverse; payments from government that decrease producers’ costs. Government provisions: where positive externalities are extremely large the government may decide to provide the product for free to everyone. |
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What is the optimal level of pollution abatement? Why? |
The optimal amount of externality reduction is where society’s marginal cost MC and marginal benefit MB of reducing the spillover are equal. |
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What is a major limitation to government’s role in the economy? |
To begin with, government officials must correctly identify the existence and the cause of any given market failure. That by itself may be difficult, time-consuming, and costly. But even if a market failure is correctly identified and diagnosed, government may still fail to take appropriate corrective action due to the fact that government undertakes its economic role in the context of politics. |
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State two government policies for controlling carbon dioxide emissions. |
1. Cap-and-trade systems 2. Carbon taxes |
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