Chapter 14: Government and Market Failure

1. Chapter 14: Government and Market Failure

2. Externalities • Negative externalities • Positive externalities

3. Negative externalities

4. Positive externality

5. Solution • Taxes or subsidies • regulations

6. Pollution • Marketable pollution permits

7. Coase theorem • If property rights are well defined and there are no transaction costs, private bargaining can correct for the presence of positive or negative externalities

8. Common property resources • Examples: • fisheries • endangered species • collective farms • communes • Solutions: • establishment of property rights • regulations

9. Public goods • A good that is nonrival in consumption • free rider problem  underproduction • Solutions: subsidies or public provision

10. Imperfect information • Asymmetric information – one party to a contract has different information than the other party • Adverse selection • Moral hazard

11. Adverse selection • Occurs when the parties who are willing to accept a contract are of “lower quality” (from the perspective of the other party) than a random member of the population • “Lemon’s problem” • Examples: used cars, insurance issues, financial markets

12. Moral hazard • Occurs when one party to a contract has an incentive to alter his or her behavior to the detriment of the other party once a contract exists

13. Solutions to asymmetric information problems • Mandated information requirements • Mandated warranties • Copayments and deductibles • Incentive-compatible contracts designed to reduce the moral hazard problem

14. Government failure • Public choice theory • Logrolling • Rent seeking