Exam 8: Market Failure Versus Government Failure

What is a government failure? List four reasons why it might occur.

What are the arguments for and against government intervention to deal with externalities?

What are the arguments for and against government intervention to deal with information problems?

The following table shows the marginal private cost (MPC) and the marginal social cost (MSC) of a chemical factory. Tons af Chenicals MPC MSC 1 100 120 2 110 130 3 120 140 4 130 150 5 140 160 Answer the following questions: (1) What is the marginal cost of the factory's externality? Is it constant at all quantities? (2) If the factory is a perfectly competitive firm and is not required by the government to internalize its external cost, how many tons should the factory produce, given that the market price of a ton of chemicals is $130? (3) If the factory is a perfectly competitive firm and is required by the government to internalize its external cost, how many tons should the factory produce, given that the market price of a ton of chemicals is $130? (4) Draw a graph illustrating your answers.

Why can imperfect information lead to market failure? Explain the adverse selection problem and give an example. How could markets for information resolve this problem?

What is the moral hazard problem? Give an example.

Demonstrate graphically and explain verbally the impact of a negative externality on a supply and demand market outcome.

What is the difference between screening and signaling? How are they similar?

Explain what a public good is and give an example. What problems are associated with determining what is a public good and how much of a public good should be provided?

What problems are associated with determining how much of a public good should be provided?

Demonstrate graphically and explain verbally the impact of a positive externality on a supply and demand market outcome.

Information problems may be a problem of the lack of a market. Explain.

The diagram below illustrates a negative externality. S is the marginal private cost and S₁ is the marginal social cost. Referencing this diagram, describe how a government can use direct regulation to eliminate the problem caused by the negative externality. What is a potential problem with this approach?

Wearing a light long-sleeved sweater adds about 2 degrees of warmth to the wearer and allows such individuals to keep their homes at 2 degrees lower temperature. Such sweaters cost approximately $20, or three for $60. The 2-degree decrease in heat can save $200 a year in heating bills. (a) Assuming that the government is committed to saving electricity, should it require people to wear such sweaters and keep their homes 2 degrees cooler? (b) What are two alternatives to this regulation? (c) If it is cheaper to keep warm with sweaters than with furnaces, why don't people voluntarily wear more sweaters?

Why can imperfect information lead to market failure?

What is the difference between a negative and a positive externality? Give an example of each.

Why do information problems constitute market failures?

What are the three alternative methods of dealing with externalities? Briefly explain each one.