Lecture 27 - Announcements We wont get to all of these slides today HW ch13 due Thursday HW for ch14 AND ch16 due on Monday Will get to ch18 before

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Announcements We won’t get to all of these slides today. HW ch13 due Thursday HW for ch14 AND ch16 due on Monday. Will get to ch18 before midterm too. 1 of 35
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2 of 22 SWITCHING GEARS: THE SOURCES OF MARKET FAILURE market failure Occurs when resources are misallocated, or allocated inefficiently. The result is waste or lost value. There are four important sources of market failure: (1) imperfect market structure, or noncompetitive behavior, (2) the existence of public goods, (3) the presence of external costs and benefits, and (4) imperfect information.
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3 of 22 THE SOURCES OF MARKET FAILURE The Problem: The conclusion that markets work efficiently rests heavily on the assumption that consumers and producers have full knowledge of product characteristics, available prices, and so forth. The absence of full information can lead to transactions that are ultimately disadvantageous. IMPERFECT INFORMATION imperfect information The absence of full knowledge concerning product characteristics, available prices, and so forth.
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Imperfect Information The first source of market failure we will consider (aside from market power) is “imperfect information”. When discussing the market economy earlier, we stated that a key element of markets is “perfect information” – everyone has full information about the prices, costs and quality of the goods they are buying and selling. Obviously this is not really the case. Normally the seller has more information about the product than the buyer. This is called “asymmetric information” Example: buying a house or a used car. 4 of 35
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5 of 35 IMPERFECT INFORMATION adverse selection Can occur when a buyer or seller enters into an exchange with another party who has more information. This can also been seen as a “hidden characteristics” problem. Basically, with adverse selection, the agent who knows more uses this knowledge in a way that harms those who don’t have the information. Sometimes, this asymmetric information can lead to something called ADVERSE SELECTION:
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Imperfect Information: Adverse Selection Example: The Lemons market Suppose potential sellers of used cars have all the information about the real quality of the car. Suppose half of used cars are “lemons” and half are “cherries” Suppose consumers are willing to pay $6000 for a cherry and $2000 for a lemon. 6 of 35
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Adverse Selection Example: The Lemons market (continued) If half the cars sold were lemons and the other half cherries then the market price would be about $4000, and consumers would have about a 50-50 chance of getting a lemon. Those with lemons would be happy to sell their cars for $4000 (since they are worth only $2000), and those with cherries don’t want to sell their car for $4000 (since they are worth $6000). As a result, only lemons would be available on
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This note was uploaded on 08/30/2011 for the course ART 3514 taught by Professor Dhbannan during the Summer '03 term at Virginia Tech.

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Lecture 27 - Announcements We wont get to all of these slides today HW ch13 due Thursday HW for ch14 AND ch16 due on Monday Will get to ch18 before

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