Chapter 14: Government and Market Failure

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Chapter 14 Government and Market Failure
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Externalities

• Negative externalities
• Positive externalities

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Negative externalities
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Positive externality
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Solution

• Taxes or subsidies
• regulations

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Pollution

• Marketable pollution permits

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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

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Common property resources

• Examples
• fisheries
• endangered species
• collective farms
• communes
• Solutions
• establishment of property rights
• regulations

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Public goods

• A good that is nonrival in consumption
• free rider problem ? underproduction
• Solutions subsidies or public provision

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Imperfect information

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

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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
• Lemons problem
• Examples used cars, insurance issues, financial
  markets

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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

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Solutions to asymmetric information problems

• Mandated information requirements
• Mandated warranties
• Copayments and deductibles
• Incentive-compatible contracts designed to reduce
  the moral hazard problem

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Government failure

• Public choice theory
• Logrolling
• Rent seeking