Chapter 9: Market Failure: Externalities and Healthcare

Four methods of government actions are available to fix inefficiencies in the face of external costs: 1. 2. 3. 4.

1. Property rights 2. Pollution taxes 3. Emissions trading 4. Command-and-control regulation

To get closer to producing the efficient quantity of education, governments can use three devices in the face of external benefits: 1. 2. 3.

1. Public provision 2. Private subsidies 3. Vouchers

Healthcare market failure results from three problems: 1. 2. 3.

1. Some people underestimate the benefit of healthcare 2. Others can't afford the healthcare they need 3. And most people want to live in a society that provides healthcare to those in greatest need.

External benefits of healthcare: 1. 2.

1. The undervalued benefits of healthy people 2. The unaffordable benefits of those with long-term care needs.

People undervalue health insurance and health care resources that stand ready to help them when needed for two reasons: 1. 2.

1. They lack the medical knowledge to correctly value the benefit of their treatment needs 2. Healthy people underestimate the health risks they face in the healthcare services they will value in the future.

Two main sources of healthcare market failure: 1. 2.

1. Underestimate benefits 2. Unaffordable

With property rights enforced, the polluter chooses the least costly of two alternatives: 1. 2.

1. Use an abatement technology 2. Produce less and pollute less

External Cost

A cost paid (borne) by people other than the producer a good or service.

Thinking about healthcare, which of the following statements is correct? A. The marginal social benefit from healthcare exceeds the willingness and ability to pay. B. The competitive market for healthcare creates a deadweight loss, but this loss is fair because it falls on the people who can afford to pay high healthcare premiums. C. The people who are fit, healthy, and able to earn an average or better-than-average income are the people who bear the deadweight loss from a competitive market in healthcare. D. The competitive market for healthcare is fair because those who are willing and able to pay receive more than enough medical attention.

A. The marginal social benefit from healthcare exceeds the willingness and ability to pay. The marginal social benefit from healthcare exceeds the willingness and ability to pay.

When does an externality arise? An externality can be created by ________. A. a production activity or a consumption activity B. people working at a production job and enjoying their work C. a production activity but not a consumption activity D. a consumption activity but not a production activity

A. a production activity or a consumption activity

What is the marginal external benefit of a good or service? Marginal external benefit is the benefit of ________. A. an additional unit of a good or service that people other than the consumer receive B. a good or service that someone other than the consumer receives C. an additional unit of a good or service that the consumer receives D. a good or service that someone other than the producer receives

A. an additional unit of a good or service that people other than the consumer receive

Students across America want tuition-free education. If education becomes tuition-free, how will the number of students enrolled change? Will the outcome be efficient? The number of students enrolled will ________ and most likely, the outcome will be ________. A. increase; inefficient B. decrease; efficient C. decrease; inefficient D. increase; efficient

A. increase; inefficient When tuition decreases, the quantity demanded increases and the number of students enrolled increases. Education has a marginal external benefit, so the efficient number of students is the number at which marginal social benefit equals the marginal cost of education. The number of students will be efficient if tuition is set equal to the marginal private benefit at the efficient number of students. If education becomes tuition-free, it is likely that the market will be inefficient.

What type of externalities are the following two items? Littering while hiking is a ________ externality. A firm doing research and development that can be used by other firms is a ________ externality. A. negative consumption; positive production B. negative production; positive consumption C. positive consumption; negative production D. positive production; negative consumption

A. negative consumption; positive production

How are most healthcare services in the United States produced, and who pays for these services? In the United States, most healthcare services are produced by private doctors and hospitals that receive their incomes from ________. A. private health insurance, the government, and patients B. only private health insurance C. only the government D. 50 percent from private insurance companies and 50 percent from patient expenditure

A. private health insurance, the government, and patients

When coal is mined, pollution occurs. The graph shows the market for coal. The government imposes a pollution tax on coal producers that results in the efficient quantity of pollution. Draw a point at the efficient market equilibrium. Draw an arrow to show the tax imposed on coal producers at the efficient quantity produced. Draw a shape that represents the tax revenue collected by the government.

Answer shown in picture. The efficient market equilibrium is determined at the intersection of the marginal social cost curve and the demand curve. When the pollution tax is set equal to the marginal external cost at the efficient quantity, then the efficient quantity of coal is produced. Total revenue is equal to the marginal external cost at the efficient quantity of coal multiplied by the quantity of coal produced.

The production of chemicals creates pollution, a negative externality. The graph shows the market for chemicals. On the graph, draw a point at the inefficient market equilibrium. Draw a shape that shows the deadweight loss created by the externality.

Answer shown in picture. The efficient outcome is the outcome at which marginal social cost equals marginal benefit, so the efficient outcome is 2 tons a week.

What is the relationship among the marginal external cost, marginal social cost, and the producers' marginal private cost? A. Marginal social cost plus marginal external cost equals marginal private cost. B. Marginal social cost equals marginal private cost plus marginal external cost. C. Marginal private cost plus marginal social cost equals marginal external cost. D. Marginal external cost equals marginal private cost minus marginal social cost.

B. Marginal social cost equals marginal private cost plus marginal external cost.

If a good has a marginal external cost, what is this cost? The marginal external cost is ________. A. equal to double the marginal private cost of the good B. an opportunity cost borne by someone other than the producer of the good C. a convenient economic concept that is not real D. expressed in dollars, so it is not an opportunity cost

B. an opportunity cost borne by someone other than the producer of the good. Marginal external cost is what someone other than the producer of the good must give up when the producer makes one more unit of the good. That is, the marginal external cost is someone's opportunity cost.

How can cap-and-trade achieve an efficient outcome? Cap-and-trade can achieve an efficient outcome by ________. A. requiring power utilities to meet EPA regulations B. confronting power utilities with the marginal social cost of their production C. fining power utilities that produce more than the efficient quantity D. forcing power utilities to pay a tax equal to the marginal external cost of production

B. confronting power utilities with the marginal social cost of their production

Describe the Canadian healthcare system. In the Canadian healthcare system, the quantity of healthcare produced ________. A. is the quantity at which marginal social benefit equals marginal social cost B. is a fixed quantity chosen by the government C. is the quantity at which marginal private benefit equals marginal social cost D. exceeds the efficient quantity

B. is a fixed quantity chosen by the government In the Canadian healthcare system, the government is the buyer of healthcare services, and it chooses the quantity to supply. A public choice, not a market equilibrium, determines the quantity of healthcare service.

Do unregulated polluting firms such as paint makers produce the efficient quantity? Polluting firms ________. A. underproduce because they don't want to pollute B. overproduce because they don't pay all the costs C. produce the efficient quantity D. overproduce because the market equilibrium price is too low

B. overproduce because they don't pay all the costs

Why would a competitive market in healthcare be inefficient? A competitive market would ________ healthcare because the marginal social benefit of healthcare ________ the consumers' marginal benefit. A. overprovide; is less than B. overprovide; exceeds C. underprovide; exceeds D. underprovide; is less than

B. overprovide; exceeds The marginal social benefit from healthcare exceeds the marginal benefit perceived by its consumers. Many people (especially healthy and young people) underestimate the health risks that they face, so they underestimate the benefit of healthcare. People take too short a view of the benefits of healthcare, so their estimate of its marginal benefit is too small. So because the marginal social benefit of healthcare exceeds the consumers' estimate of its marginal benefit, a competitive market in healthcare would underprovide it.

The Patient Protection and Affordable Care Act created health insurance marketplaces. Who was on the supply side of these markets? Who was on the demand side? On the supply side of the health insurance markets are ________ and on the demand side are ________. A. governments; people with no health insurance B. private insurers; the uninsured and those looking for a better plan C. medical practitioners; people who are unwilling to pay for private health insurance D. hospitals; people looking for cheaper health insurance

B. private insurers; the uninsured and those looking for a better plan The Patient Protection and Affordable Care Act created health insurance marketplaces so that people could compare insurance plans. The suppliers of health insurance are the private insurance companies. The demanders of health insurance are those who are uninsured and those looking for a better insurance plan.

A wind farm off Cape Cod with 130 noisy turbines that stand 440 feet tall and that can be seen from the coast will produce power for 75 percent of nearby homes. Does this wind farm create an externality? The wind farm creates an externality if ________. A. sea birds are not injured by the turbines B. residents find that the turbines spoil the scenery C. the turbines produce power for more than 75 percent of nearby homes D. the turbines fail to produce power for 75 percent of nearby homes

B. residents find that the turbines spoil the scenery

How does a cap-and-trade work to reduce emissions? When a cap-and-trade is implemented, ________. A. the government subsidizes firms that pollute B. the government determines the efficient quantity of emissions and firms buy and sell the allocated permits C. the government allocates permits to firms that pollute the least and other firms either cut their emissions or leave the market D. firms determine the efficient quantity of emissions and the quantity of permits, which they allocate among themselves

B. the government determines the efficient quantity of emissions and firms buy and sell the allocated permits A cap is a quota on emissions. The government first estimates the efficient quantity of emissions and sets the overall cap at that level. A cap is then allocated to individual firms. Firms that have a low marginal abatement cost sell permits and make big cuts in emissions. Firms that have a high marginal abatement cost buy permits and make smaller cuts or no cuts in emissions. The market in permits determines the equilibrium price of pollution and each firm maximizes profit by setting its marginal cost of emissions or marginal abatement cost, whichever is lower, equal to the market price of a permit. The total amount of emissions equals the emissions quota.

What problems exist that make healthcare a government-provided service? One such problem is that consumers and potential consumers of healthcare ________. A. would otherwise have too many unnecessary medical procedures B. underestimate its benefit and their future needs C. have difficulty finding a primary care physician D. believe that the private healthcare market is unfair

B. underestimate its benefit and their future needs

Complete the following sentence. When a market failure arises because marginal social benefit exceeds the ability and willingness to pay, economists suggest that ________. A. supply be increased B. vouchers be used C. demand be increased D. taxes be raised

B. vouchers be used When a market failure arises because marginal social benefit exceeds the ability and willingness to pay, economists suggest that vouchers be used. A voucher is a token that can be used to buy only the item that the voucher specifies.

What is the relationship among marginal social benefit, marginal private benefit, and marginal external benefit? A. MB − marginal external benefit = MSB B. MSB − marginal external benefit = MB C. Marginal external benefit − MB = MSB D. MSB + marginal external benefit = MB

B. MSB = MB + marginal external benefit. Rewriting the equation, you can see that MSB − marginal external benefit equals MB.

Choose the correct statement about the Patient Protection and Affordable Care Act A. A major problem with the act is that insurance companies can deny coverage of pre-existing conditions. B. This act makes U.S. healthcare both efficient and fair. C. A family pays the price received by the insurer minus a subsidy that depends on the family's size and income. D. The government is on the supply side of the healthcare market.

C. A family pays the price received by the insurer minus a subsidy that depends on the family's size and income. A family pays a premium equal to the price received by the private insurer minus a subsidy that depends on the family's size and income.

Are externalities positive or negative? Give an example. Externalities ________. A. can be negative or positive. A negative externality is having to go to school when you would rather go to the beach and a positive externality is spending time with your friends B. are always negative, and an example is the pollution created by trucks C. can be negative or positive. Logging creates a negative externality, and education has a positive externality D. are always positive, and an example is flu vaccinations

C. can be negative or positive. Logging creates a negative externality, and education has a positive externality

When does a positive externality arise? A good or service generates a positive externality if ________. A. its marginal private benefit is maximized B. its marginal external benefit exceeds its marginal private benefit C. its marginal social benefit exceeds its marginal private benefit D. it is produced in the social interest

C. its marginal social benefit exceeds its marginal private benefit

How do school vouchers influence the efficiency of the education market? Efficiency increases because vouchers ____________________. A. Increase the demand for education, so enrollment increases B. Decrease marginal private cost without changing enrollment C. Lower tuition, so enrollment increases D. Increase the marginal social benefit, so everyone benefits.

C. Lower tuition, so enrollment increases Vouchers lower tuition, so enrollment increases down along the demand curve. If the voucher equals the marginal external benefit, the efficient number of students will enroll.

How does a pollution tax work to reduce emissions? A. It increases producers' costs so that they decrease the quantity produced to the point at which pollution is eliminated. B. A tax equal to marginal social cost minus marginal social benefit results in the efficient amount of pollution. C. It eliminates external costs so that firms produce the efficient quantity and emit the efficient amount of pollution. D. It increases producers' costs and decreases production, which decreases emissions.

D. It increases producers' costs and decreases production, which decreases emissions. A pollution tax forces producers to take account of the external costs they impose on society. Producers' costs increase, and in response, they decrease their production, which decreases pollution emissions.

Steel production creates pollution. What happens if a tax is imposed on steel production equal to the marginal external cost of the pollution? The pollution tax ________. A. will not change the quantity of steel produced B. cuts pollution to zero C. raises the market price of steel by the amount of the tax D. cuts the deadweight loss created by steel producers to zero

D. cuts the deadweight loss created by steel producers to zero. If a tax is imposed on steel production equal to the marginal external cost of the pollution, steel producers face the total cost of production and the efficient quantity of steel is produced. When production is efficient, the deadweight loss is zero.

A healthy person lowers the costs of a government-funded medical system. What type of externality results? This is an example of a ________ externality. A. positive production B. negative consumption C. negative production D. positive consumption

D. positive consumption

Example of positive production externality

Education, which produces skilled workers who then go on to further develop technology etc..

Positive Externality

Imposes external benefit

Negative Externality

Imposes external cost

Marginal Private Cost (MC) _________________ as production increases

Increases

Marginal External Cost (MEC) _________________ as production increases

Increases Example: A fish already dealing with a little pollution will get increasingly overwhelmed with each additional gallon

Using an abatement technology ________________ the cost of production, ______________ the equilibrium price, and makes the cost of avoiding pollution a ______________ cost.

Increases; raises; private

MSB= _______________ + _______________

MB + MEB

Marginal Social Cost (MSC) = __________________________ __________________________ __________________________ + __________________________ __________________________ __________________________

Marginal Social Cost (MSC) = Marginal Private Cost (MC) + Marginal External Cost (MEC)

A more severe externality is an increase in ______________________________________, which increases ____________

Marginal external cost; MSC

Four types of externalities

Negative production, Positive production, negative consumption, postive consumption

In graph 9.2.3, ________________ the cost of production, and ________________ determines supply

Polluters; MSC Because polluters have property rights, they bear the cost of pollution. Their supply decisions are based on marginal social cost.

Example of negative production externality

Pollution, affecting wildlife and the general population

An economic analysis of a negative externality distinguishes between ________________ and ________________ costs.

Private; Social

Example of negative consumption externality

Smoking causing 2nd hand smoke, leaving beer bottles on the beach, dogs barking and keeping neighbors up

Private Cost

The cost borne by the producer of a good or service.

Marginal Cost

The cost of producing one more unit of a good.

Marginal Social Cost (MSC)

The marginal cost incurred by society (by the producer AND by everyone else on whom the externality falls)

Example of positive consumption externality

Vaccinations, which protect not only those who get vaccinated, but everyone else too

Externality

an economic side effect of a good or service that generates benefits OR costs to someone other than the producer OR consumer

An external benefit is a ____________ that someone other than the consumer receives. A Marginal External Benefit (MEB) is the benefit from an additional unit of good or service that people other than the _______________ of that good enjoy.

benefit; consumer

The presence of external _______________ brings inefficient underproduction.

benefits

Cap-and-Trade, also called emissions trading, imposes a ________ on total emissions and assigns or sells tradable emission rights to individual ________________

cap; producers

A private benefit is a benefit that the _______________ of a good or service receives. The Marginal Private Benefit (MB) is the benefit from an additional unit of good or service that the _______________ of that good receives.

consumer; consumer

Government expenditure on healthcare under Medicare and Medicaid programs is determined by ________________, And as the population ages, this expenditure will ____________.

demand; grow

If all education is provided by private schools that charge full-cost tuition, why is the market equilibrium number of people in school too low? It is too low because market _______________ is based on _______________, which is too low

demand; marginal private benefit

Total revenue is equal to the marginal external cost at the _______________ quantity of (product) multiplied by the quantity of (product) produced.

efficient

To use cap-and-trade, a government estimates the ________________ quantity of emissions, sets an overall cap, and allocates ________________ permits to individual firms

efficient; emission

By setting the subsidy ___________ to marginal external benefit, the government can induce private schools to enroll the efficient number of students.

equal

A subsidy is a payment by the _________________ to a producer to cover part of the costs of production. By giving producers a subsidy, the government can induce ______________ decision makers to consider the _______________ benefits when they make their choices.

government; private; external

Vouchers are tokens that the government provides to ______________________, which they can use to buy specified goods or services.

households

Establishing property rights where they do not currently exist can confront producers with the costs of their actions and provide them with an _________________ to allocate resources _________________

incentive; efficiently This forces them to take all the costs of their actions into account

A voucher given to students ______________ the demand for school by adding the value of the voucher to the willingness to pay for tuition. The demand curve shifts from MB to MB plus voucher.

increases

An increase in the external benefit of education _______________ the marginal social benefit of education. The MSB curve shifts upward and the efficient enrollment increases.

increases

When marginal external benefit increases, marginal social benefit _______________

increases

When marginal external cost increases, marginal social cost ________________

increases

When marginal external cost increases but MC (marg. cost) and MB (marg. benefit) stay the same, deadweight loss __________________, efficient quantity _________________, and price __________________

increases; decreases; increases

When marginal social cost exceeds marginal social benefit, the market equilibrium is ____________________

inefficient

Property rights are __________________ established titles to the ownership, use an disposal of factors of production and goods and services that are enforceable in the court

legally

The Coase theorem states that: If property rights exist and the cost of enforcing them is ________, the market outcome is __________________ and it doesn't matter who has the property rights

low; efficient

If all schools are private, why would the government offer a subsidy to schools? The government would offer a subsidy to schools in order to ____________ marginal private costs to increase enrollment. This incentivizes schools to offer students lower tuition, ______________ enrollment.

lower; increasing

Demand is based on ______________

marginal private benefit

Public universities, colleges, and schools set the tuition equal to _____________ _____________ _____________ at the efficient quantity. This level of tuition ensures that the _____________ number of students enroll.

marginal private benefit; efficient

Transaction costs are the ________________ costs of conducting a transaction.

opportunity

When external costs are present, ________________ exceeds the efficient quantity and we get more than the efficient quantity of pollution.

output

An ______________ occurs when MSB is less than MC.

overprovision

An abatement technology is a production technology that reduces or prevents ________________

pollution

Pollution Taxes, also called Pigovian Taxes, are taxes on polluting ________________ set at a level that confronts ________________ with the external costs of their actions

production; producers

Public provision is the production of a good or service by a _____________ authority that receives most of its ________________ revenue from the government.

public; revenue

Why would a health care market with no government actions under provide healthcare? It would under provide healthcare because the marginal ________ ________. of healthcare exceeds the marginal ________ ________.

social benefit; private benefit

Command-and-Control Regulation is the setting of ________________ that define what is and is not legally permitted, and direct ________________ to ensure that the standards are met

standards; monitoring Most govts./countries use CCR to improve air and water quality

A pollution tax is imposed equal to the marginal external cost of pollution. The _____________ curve now becomes the MSC curve

supply

How does a subsidy paid to private schools change the market outcome? It changes the market outcome by increasing ______________. A subsidy paid to private schools lowers their marginal cost, allowing them to increase supply. The greater supply lowers tuition and increases the quantity demanded, but does not increase demand.

supply

By imposing a _______ set equal to its Marginal External cost, a firm can be induced to behave the same way as it would if it had bore the cost of the ___________________ directly

tax; externality

Marginal External Cost (MEC)

the cost of producing an additional unit of a good or service that falls on people other than the producer

Marginal Private Cost (MC)

the cost of producing an additional unit of a good or service that is borne by the producer of that good or service