Class 22-2010 Revised - C295: Class 22 Market Failure and...

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THE UNIVERSITY OF BRITISH COLUMBIA 1 C295: Class 22 – Market Failure and Externalities Today: 1. Review questions on the agency problem. 2. Overview of Market Failure 3. Introduction to Externalities 4. Externalities Cause Inefficiency 5. Correcting Externalities 6. Global Warming 7. Summary
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THE UNIVERSITY OF BRITISH COLUMBIA Announcements 2 Assignments will be returned next class. The assignment was well done. You can see how you did on the multiple choice (MC) on Vista by using the “My Grades” tab. A few people did not successfully submit answers. Those people will need to see me to sort things out. I will go over the structure of the final exam next class. I will also cover review questions. Textbook: You only need to use the textbook to help you understand what we cover in class and on the assignments. You are not responsible for other material in the textbook.
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THE UNIVERSITY OF BRITISH COLUMBIA 1. Agency Review Questions: Clicker Question 1 3 Bad Luck Good Luck Low Effort 10 40 High Effort 40 80 The matrix shows net income for the firm as a function of luck and managerial effort. The probabilities 40% for bad luck and 60% for good luck. Low effort imposes no cost on the manager. High effort costs 10. The owner and the manager are both risk neutral. Which statement is true? a. With a fixed wage of 10 the expected return to the owner exceeds 20. b. If net income is shared 50-50, the owner’s expected return exceeds 30. c. The owner is like an agent acting on behalf of the manager. d. All of the above. e. None of the above.
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THE UNIVERSITY OF BRITISH COLUMBIA Clicker Question 2 4 In recent years large corporations in North America have used options to provide more than half of the compensation received by senior executives. Which of the following statements is true. a) Options function more like profit-sharing contracts than like bonus contracts. b) Options granted to senior executives allow them to purchase an unlimited amount of corporate stock at a fixed price for some period of time. c) Options have been criticized for inducing an emphasis on long run performance at the cost of reduced short run performance. d) All of the above. e) None of the above.
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2. Overview of Market Failure 5 Market failure means the failure of a market be efficient – the failure to maximize surplus. We established early in the course that perfect competition is efficient – that is maximizes combined surplus to consumers and producers. One way of understanding this point is to note that under perfect competition marginal benefit is equated to marginal cost, which is needed to maximize surplus. The reasoning is as follows: MB = P because price shows the marginal willingness to pay. P = MC because under this is the profit-max condition under competition.
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This note was uploaded on 01/19/2011 for the course COMMERCE 290 taught by Professor Brianogram during the Spring '09 term at The University of British Columbia.

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Class 22-2010 Revised - C295: Class 22 Market Failure and...

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