ECO-231: Chapter 4: Market Failures Caused by Externalities and Asymmetric Information

What is the shape of the marginal benefit curve for pollution reduction?

downward sloping

The marginal benefit curve for pollution reduction slopes ______ because of the law of ______.

downward; diminishing marginal utility

Economic (one word) is achieved at the equilibrium quantity.

efficiency

The optimal reduction of an externality occurs when society's marginal cost ______ the marginal benefit of reducing that externality

equal to

A polluting producer's supply curve lies farther to the than it does when the firm bears the full costs of production.

right

When a producer's supply curve is to the right of (or below) the total-cost supply curve, this represents the fact that its ______.

supply curve does not capture all the costs legitimately associated with the production of its goods

Direct controls on pollution raise the marginal cost of production because ______.

the firms must purchase, operate, and maintain pollution-control equipment

Which of the following is a common remedy when externalities affect large numbers of people or community interests are at stake?

Government intervention

True or false: Efficiency losses are reductions of combined consumer and producer surplus associated with both underproduction and overproduction of a product.

True

True or false: Markets that have downward-sloping demand curves and upward-sloping supply curves yield consumer and producer surplus.

True

Which of the following are signs of a market failure?

Underallocation of resources Overallocation of resources

In which situation are buyers capable of taking advantage of sellers?

When buyers possess more information than sellers

Which of the following are situations in which governments likely to intervene in markets?

When externalities affect large numbers of people When community interests are at stake

In which situation are governments likely to use subsidies or government provision to achieve economic efficiency?

When positive externalities cause underproduction

When does the optimal reduction of an externality occur?

When society's marginal cost and marginal benefit are equal

Which of the following is a resource that lending institutions can use to overcome information problems when considering a loan application?

credit bureaus

What kind of relationship exists between equilibrium price and the amount of producer surplus?

Positive

When is allocative efficiency of a product achieved?

When the correct quantity of the product is produced relative to other goods and services

When are governments most likely to impose licensing restrictions in markets featuring inadequate buyer information about sellers?

When the marginal cost of obtaining information about sellers is excessively high

Reducing a(n) externality has a cost and society must decide how much of a reduction in the externality it wants to pay for.

negative

A(n) to a producer is a payment from the government to decrease a producer's cost in order to encourage more output of a product deemed beneficial to society. (Remember to type only one word in the blank.)

subsidy

Points on the curve represent marginal cost.

supply

The seller's minimum acceptable price at each unit of the product forms a point on the curve, also known as the marginal cost curve. (Remember to type only one word in the blank.)

supply

The size of the deadweight loss will get smaller when output is increased and ______.

the maximum willingness to pay exceeds acceptable prices

Government subsidies decrease producers' costs, shifting the supply curve to the ______ and correcting the ______ of resources by producers.

right; underallocation

When government subsidizes producers, it is attempting to ______.

shift supply to the right

Completely eliminating a negative externality may be considered undesirable due to the ______.

high costs of eliminating negative externalities

How does adverse selection manifest itself in the insurance industry?

hose who are most likely to need insurance payouts are the most likely to purchase insurance.

Which of the following are subsidies to consumers to correct for an underallocation of resources by producers?

A discount coupon to inoculate children against classic childhood diseases A tax credit for purchasing an electric car

Which type of intervention has the government primarily used to discourage or limit harmful air pollution?

Direct controls

Identify policies for coping with the overallocation of resources caused by negative externalities.

Direct controls Taxes on producers

Which of the following situations are affected by moral hazard?

Doctors obtaining medical malpractice insurance Workers being covered by unemployment insurance Professional athletes receiving guaranteed contracts

What can be expected to occur in the market when the government makes use of buyer subsidies to correct a positive externality?

The demand for the good causing the externality will rise, resulting in the demand curve shifting outward.

Based on the reality of political pressures, such as the need to satisfy constituents, which of the following statements is true?

The economic role of government is not always perfectly carried out.

Why does a firm's supply curve shift to the right when negative externalities are present?

The firm is not paying the full cost of production.

A deadweight loss is also known as ______.

an efficiency loss

Consumer surplus can be illustrated as the area _____ the demand curve and ______ the market price.

below; above

Consumer surplus and price are _____ related.

inversely

The optimal reduction of an externality occurs when society's marginal cost ______ the marginal benefit of reducing that externality.

is equal to

All markets that have downward-sloping demand curves and upward-sloping supply curves yield and surplus. (Remember to type only one word per blank.)

Blank 1: buyer or consumer Blank 2: seller, producer, or supplier

Which of the following could give rise to a negative externality?

A coal generated power plant

What is adverse selection?

A situation in which one party in a contract lacks information about the other party and incurs major costs as a result.

Select all of the reasons why completely eliminating pollution may be undesirable.

Additional actions to reduce pollution will lower society's well-being because total cost will rise more than total benefit. At some point, marginal cost (MC) may rise so high that it exceeds society's marginal benefit (MB) of further pollution abatement.

Which term describes a situation in which the first party to a contract possesses information not known to the second and, as a result, the second party incurs major costs?

Adverse selection

What is achieved when output is produced at the point at which maximum willingness to pay exactly equals the minimum acceptable price?

Allocative efficiency

Which of the following are achieved at the equilibrium quantity of a good or service?

Allocative efficiency Productive efficiency

What causes the shift in the supply curve for a firm targeted by a Pigovian tax?

An increase in marginal cost

What is a situation in which one party to a market transaction possesses substantially more information than the other party?

Asymmetric information

A form of economic efficiency called _ is achieved when resources are directed toward their highest-valued use. (Enter one word in each blank.)

Blank 1: allocative Blank 2: efficiency

Which of the following are likely reactions by market participants in a market characterized by inadequate buyer information about sellers?

Buyers and sellers support government intervention Buyers opt out of the market

How might sellers respond to a situation in which lack of buyer information about sellers resulted in buyers opting out of the market?

By welcoming government intervention

Which of the following are subsidies to producers to correct for an underallocation of resources caused by a lack of consumer demand for a product beneficial to society?

Cash payment from government to pharmaceutical firms making vaccines Tax credit to vaccine drug makers

Which of the following are direct controls that have been used by the US government to address pollution?

Clean-water legislation Emission standards Toxic-waste laws

___ is defined as the difference between the maximum price a consumer is willing to pay for a product and the actual price.

Consumer surplus

Which of the following refers to reductions of combined consumer and producer surplus associated with the underproduction or overproduction of a good or service?

Deadweight loss

How do positive externalities affect demand curves?

Demand curves shift to the left.

Which steps has the government taken to address the problem of inadequate buyer information about sellers in the gasoline market?

Employing inspectors to check for accuracy of pumps Establishing a system of weights and measures Passing laws against false or misleading advertising

True or false: Government could correct the overallocation of resources by subsidizing consumers of the product.

False

True or false: When positive externalities occur, the market demand curve lies to the right of the total-benefits demand curve.

False

True or false: When the benefits of pollution abatement exceed the costs to the community and society, the spending of scarce resources by government on other societal projects may be the best decision.

False

True or false: Competitive markets produce equilibrium prices and quantities that minimize the sum of consumer and producer surplus.

False They maximize the sum of consumer and producer surplus.

Which of the following are methods that private businesses can use to overcome information difficulties without government intervention?

Franchising Product warranties

Which of the following markets are more likely to experience positive externalities?

Immunizations Education

Which of the following are effects of adverse selection on the insurance industry?

Insurance premiums go up. The insurance pool is dominated by high risk.

How has government intervention in the gasoline market affected market participants?

It has benefited both buyers and sellers.

What effect would the moral hazard problem have on the behavior of individuals who obtain insurance against the financial risks of divorce?

It makes them more likely to file for divorce.

What effect does moral hazard have on the behavior of professional athletes who receive a guaranteed contract?

It may reduce the quality of their performance.

Which of the following is a policy approach to negative externalities?

Levying taxes or charges on the related good

Which of the following reduces producer surplus?

Lower prices

Which term describes the inability of a market to bring about the allocation of resources that best satisfies the wants of society?

Market failure

The market demand curve for positive externalities reflects ______.

only the benefits to those who pay for and use the product

Which term describes a situation in which a person or institution behaves more recklessly after they obtain contracts that shift the financial burden of bad outcomes onto others?

Moral hazard

Legislation limiting specific activities is the most direct method of addressing which market situation?

Negative externalities

Pigovian taxes and direct controls are two government solutions for which market situation?

Negative externalities

What kind of market situation results in equilibrium output being larger than optimal output, leading to an overallocation of resources?

Negative externalities

Which of the following results in an overallocation of resources to the production of a good or service?

Negative externality

What occurs in a market transaction characterized by asymmetric information?

One party possesses significantly more information than the other party.

The government can correct for a situation in which negative externalities result in the overallocation of resources by using which of the following types of interventions?

Pigovian taxes Direct controls

Which of the following are solutions that governments use to counter overproduction caused by negative externalities?

Pigovian taxes Direct controls

_ surplus is the difference between the actual price a seller receives and the minimum acceptable price.

Producer or Supplier

What is the difference between the actual price a seller receives and the minimum acceptable price?

Producer surplus

What is achieved when competition forces producers to minimize the per-unit cost of the output they produce?

Productive efficiency

True or false: A subsidy to a producer is a payment from the government to decrease the producers' cost to encourage more supply of a product beneficial to society.

True

In the figure, which of the following statements concerning positive externalities are correct?

Quantity point Qe represents the equilibrium output point. Quantity point Qo represents the optimal output point.

What is the market result of a situation in which buyers possess more information than sellers?

Reduced market activity

What is the primary effect of the moral hazard problem on private markets?

Resources are underallocated to the good or service affected by moral hazard.

Solar panels provide a benefit those who buy them by reducing their electricity bill, but they also benefit society as a whole by reducing pollution and resource consumption. Because producers calculate demand based on actual purchases rather than total benefit, solar panels are underproduced. Which types of government intervention could be used to counter this situation?

Subsidies Government provision

Which government interventions can be used to counter underproduction caused by positive externalities?

Subsidies Government provision

To encourage consumers to buy more energy-efficient appliances, the government offers cash rebates to consumers who purchase products that have received Energy Star certification. This is an example of which type of government intervention?

Subsidies to buyers

Which type of government intervention is likely to result in the demand curve shifting to the right (outward)?

Subsidies to buyers

To encourage the development of beneficial technologies, the government provides direct payments to independent research laboratories. This is an example of which type of government intervention?

Subsidies to producers

Which type of government intervention seeks to increase the supply of a beneficial good?

Subsidies to producers

Identify policies for coping with the underallocation of resources associated with positive externalities.

Subsidies to producers Government provision Subsidies to consumers

Which curve shows the seller's minimum acceptable price for each unit of the product?

Supply curve

A specific tax applied to the producer of a good in order to correct a negative externality will cause what change to the market for that good?

Supply curve shifts left

_____ provides goods to correct a positive externality where positive externalities are extremely large.

The government

Which of the following are likely to occur if the technology for pollution-control equipment improves noticeably?

The marginal cost curve of abatement would shift rightward. The cost of pollution abatement would fall. The optimal quantity level of abatement would rise.

True or false: At the equilibrium output, where the demand and supply curves intersect, marginal benefit equals marginal cost.

True

In the figure, which of the following statements concerning positive externalities that accrue to society are correct?

The optimal output point is on market demand curve Dt. The equilibrium output point is on market demand curve D.

n the figure, which of the following statements concerning positive externalities that accrue to society are correct?

The optimal output point is on market demand curve Dt. The equilibrium output point is on market demand curve D.

Which of the following would be likely to happen in a society that decided it wanted cleaner air and water because of new information about the adverse health effects of pollution?

The optimal quantity level of pollution control would increase. The marginal benefit (MB) curve of abatement would shift rightward.

Which of the following are pressures that make government more likely to produce undesirable economic outcomes?

The pressure to accrue benefits to firms in the politician's home state The pressure to be elected and earn reelection

Why does government impose licensing or oversight restrictions on some markets characterized by a lack of buyer information about sellers but not others?

The process of obtaining information in some markets imposes unacceptably high human and economic costs.

Which of the following are the effects of a subsidy to producers?

The quantity of the product increases to the economically optimal quantity, eliminating the underallocation of resources. The supply curve shifts to the right because of an increase in supply. The subsidy reduces the marginal cost of producing the good.

In competitive markets where demand curves reflect buyers' full willingness to pay and supply curves reflect all the costs facing sellers, what is maximized when output equals the equilibrium quantity?

The sum of consumer and producer surplus

For a given supply curve, how do higher prices affect producer surplus?

They increase it.

Moral hazard is a situation in which people or institutions behave more recklessly after which of the following happens?

They obtain insurance or a contract that shifts the financial burden of bad outcomes onto others.

What is the purpose of a Pigovian tax?

To discourage the production of a good that causes negative externalities

Is there a relation between consumer surplus and price?

Yes, they are inversely related

A form of economic efficiency called Blank 1, efficiency is achieved when the quantity of output at equilibrium is produced.

allocative

A form of economic efficiency called efficiency is achieved when the quantity of output at equilibrium is produced.

allocative

The area depicted below the demand curve and above the market price is known as ______.

consumer surplus

A cost or a benefit accruing to an individual or group that is external to a market transaction is known as a(n) ______.

externality

A(n) (Enter one word) is a cost or a benefit accruing to an individual or group, a third party, that is external to a market transaction

externality

Government provision refers to the government's providing a good or service for free in order to correct for ______.

extremely large positive externalities

True or false: Negative externalities, such as pollution, improve rather than reduce the utility of people and the communities in which they live and work.

false

The result of positive externalities is that the market produces too ______ units of a product that could benefit society, resulting in producers ______ resources to that product.

few; underallocating

A government provision is a good or service provided _______ in order to correct for very large _______ externalities.

for free to everyone; positive

A person who receives benefits from a market transaction without having to pay for them is called a(n) rider.

free

People who receive the benefits from a good without having to pay for it are known as ______.

free riders

When positive externalities occur, the market demand curve lies to the ______ the total-benefits demand curve.

left of (below)

A less-direct action than passing legislation to correct a negative externality is for the government to ______.

levy a specific tax on the producers of the related good

As a result of negative externalities that are imposed by producers, costs are transferred to society and therefore firms incur ______ production costs and have supply curves that are ______ the full cost associated with producing their goods.

lower; below

What do points on the demand curve represent?

marginal benefit

The intersection of the demand and supply curves at the equilibrium output indicates that ______.

marginal benefit equals marginal cost

The ______ curve for positive externalities reflects the benefit to the individuals who pay for the product.

market demand

Allocative efficiency occurs at quantity levels where the combined consumer and producer surplus is ______.

maximized

Consumer surplus is the difference between the ___ price a consumer is willing to pay for a product and the price paid.

maximum

Productive efficiency is achieved when production costs are _____.

minimized

A market failure that occurs when a third party to a transaction experiences uncompensated costs is called a(n) externality, or spillover cost.

negative

Another policy approach to externalities is for government to levy a tax or charge specifically on the related good.

negative

If a market transaction imposes an uncompensated cost on a third party not directly involved in the transaction, the transaction results in a market failure known as a ______.

negative externality

Negative externalities (or spillover costs) result in a(n) ______ of resources to the production of the good.

overallocation

A negative externality results when there is an ______ of resources to the production of a good and too ______ units are produced.

overallocation; many

The direct way to reduce negative externalities from a certain activity is to ______.

pass legislation limiting that activity

The government will provide a public good where there are extremely large externalities.

positive

Vaccinations against common diseases are an example of a ______ externality.

positive

There is a(n) (positive/negative) relationship between equilibrium price and the amount of producer surplus.

positive or direct

Direct controls the marginal cost of production because firms must operate and maintain pollution control equipment.

raise

Negative externalities, such as pollution, ______ the utility of those affected.

reduce

Private bargaining, markets for externality rights, specific taxes, liability rules and lawsuits, and direct controls are all examples of methods for correcting ______.

the overallocation of resources caused by negative externalities

Government can correct the ______ of resources by subsidizing consumers of the product.

underallocation

Some individuals do not directly consume a product but accrue indirect benefits from others who do consume the product. As a result, there is a(n) ______.

underallocation of resources to the beneficial product

Private bargaining, subsidies to producers, subsidies to consumers, and government provisions are all ways for correcting the ______ of resources associated with ______ externalities.

underallocation; positive

When positive externalities exist, demand curves fail to reflect the willingness to pay of the people who receive the positive externality, resulting in products being ______.

underproduced