L7 - Market Failure Ch 10, 11= BB

L7 - Market Failure Ch 10, 11= BB - MarketFailure Market...

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Market Failure Market failure occurs when an imperfection in the market mechanism prevents optimal outcomes. The forces of supply and demand do not lead us to the best point on the production-possibilities curve.
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Market Failure All Other Goods (units per time period) Cigars (units per time period) Production possibilities X ( Optimal mix) M ( Market  mix)
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Public Goods Rivalry One person’s consumption of a unit of a good or service means that no one else can consume that unit Excludability The ability to exclude those who do not pay for a good from consuming it Pure private good Is both rivalrous and excludable
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The Different Kinds of Goods Private goods : excludable, rival in consumption example: food Public goods : not excludable, not rival example: national defense Common resources : rival but not excludable example: fish in the ocean Natural monopolies : excludable but not rival example: cable TV
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Public Goods Public goods are difficult for private markets to provide because of the free-rider problem . Free rider : a person who receives the benefit of a good but avoids paying for it If good is not excludable, people have incentive to be free riders, because firms cannot prevent non-payers from consuming the good. Result: The good is not produced, even if buyers collectively value the good higher than the cost of providing it.
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The Tragedy of the Commons Setting: a medieval town where sheep graze on common land. As the population grows, the # of sheep grows. The amount of land is fixed, the grass begins to disappear from overgrazing. The private incentives (using the land for free) outweigh the social incentives (using it carefully). Result: People can no longer raise sheep.
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Common Resources Like public goods, common resources are not excludable. Cannot prevent free riders from using Little incentive for firms to provide Role for govt: seeing that they are provided Additional problem with common resources: rival in consumption Each person’s use reduces others’ ability to use Role for govt: ensuring they are not overused
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What could the townspeople (or their government) have done to prevent the tragedy? Try to think of two or three options. Class Exercise Class Exercise         Policy options for common resources Policy options for common resources 8
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Impose a corrective tax on the use of the land to “internalize the externality.” Regulate use of the land (the “command-and- control” approach). Auction off permits allowing use of the land. Divide the land, sell lots to individual families; each family will have incentive not to overgraze its own land. Class Exercise
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This note was uploaded on 12/02/2011 for the course ECON 200 taught by Professor Vincent during the Fall '08 term at Maryland.

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L7 - Market Failure Ch 10, 11= BB - MarketFailure Market...

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