Chapter 14 Government and Market Failure Externalities n

Chapter 14: Government and Market Failure

Externalities n n Negative externalities Positive externalities

Negative externalities

Positive externality

Solution n n Taxes or subsidies regulations

Pollution n Marketable pollution permits

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

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

Public goods n n n A good that is nonrival in consumption free rider problem underproduction Solutions: subsidies or public provision

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

Adverse selection n 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

Moral hazard n 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

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

Government failure n n n Public choice theory Logrolling Rent seeking