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16 - Missing Markets - Missing Markets and Externalities...

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1 Missing Markets and Externalities Economics 401 Missing Markets and Externalities MISSING MARKETS: Some goods are not traded even when such trade would be mutually beneficial Examples: Insurance Trade between countries EXTERNALITIES Exist if at fixed prices an action by one agent affects another agent’s utility or production This is a missing markets problem Missing Markets: An Example h) b, (a, h b a U ) (20,30,100 ω h b a U (80,70,0) ω R R R R R F F F F F + + = = + + = = Two agents: Felix (F) and Oscar (R) No market for good h Three goods: a,b,h
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2 Missing Markets: An Example ) 100 , 30 , 20 ( ω ) 0 , 70 , 80 ( ω R F = = C * F = (75,75,0) C * R = (25,25,100) 25 25 C* 70 80 ϖ F R 100 100 U R =20 1 MRS F b a, = Competitive Equilibrium 1 P P b a = 1 MRS R b a, = Missing Markets: Inefficiency of Market Equilibrium and in competitive equilibrium: C * F = (75,75,0) , C * R = (25,25,100) U * F = 150 , U * R = 20 Pareto-dominating allocation: C † F = (51,51,51) U † F = 153 >150 C † R = (49,49,49) U † R = 21 > 20 Felix relinquishes 49 units of good h but gets more of the other two R R R R R F F F F F h b a U ) 100 , 30 , 20 ( ω h b a U ) 0 , 70 , 80 ( ω + + = = + + = = Recall: Why a Pareto Improvement is Possible Pareto improvement is possible because in
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