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Chapter 12 (2) - Coggle Diagram
Chapter 12 (2)
Unit 9
Sometimes a combination of remedies is the best way to cope with these information problems and resulting market failures
Microeconomic models are models of interaction between individual employers and employees, borrowers and lenders, firms and their customers and firms competing with other firms
Governments play an important role in the economy in their attempts to diminish the inefficiencies associated with many kinds of market failures
Governments also address problems of inequality and poverty by redistributing income from richer to poorer households. But public policies are aimed at many other objectives including:
- Moderating fluctuations in employment and inflation
- Wages, profits and productivity in the long run
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Unit 10
Both Coasean bargaining and Pigouvian taxes and subsidies can improve on market outcomes in these cases, but both are limited by the same problems of asymmetric and non-verifiable information that is the reason for the market failure
Repugnance and other moral objections to exchanging some goods for money and the crowding out effects of monetary incentives, provide reasons why some goods and services are not allocated using markets
Externalities occur when some aspect of an exchange is not covered by an enforceable property right or contract, as a result of asymmetric or non-verifiable information. Examples include employment, credit and insurance contracts and public goods and bads
Pareto inefficient market outcomes (market failure) can result from limited competition, average costs declining with output, or external effects
Unit 6
Another example of the problem of hidden attributes (adverse selection) is health insurance. This is also an example of a missing market: many people will be uninsured. It is a market that could exist, but only if health information were symmetrical and verifiable. Not having such a market is Pareto inefficient. To address the problem of adverse selection due to asymmetric information, and the resulting missing markets for health insurance, many countries have adopted policies of compulsory enrolment in private insurance programs or universal tax-financed coverage
Hidden attributes are not the only problem facing insurers, whether private or governmental. There is also a problem of hidden actions. Buying an insurance policy may make the buyer more likely to take exactly the risks that are now insured.
A common reason for contracts to be incomplete is that information about an important aspect of the interaction is unavailable or unverifiable. Information is often asymmetric - one party knows something relevant to the transaction that the other doesn't know. Forms of asymmetric information:
- Hidden action
- Hidden attributes. When you want to purchase a used car, for example, the seller knows the quality of the vehicle. You do not. This attribute of the car is hidden from the prospective buyer. Hidden attribtutes can cause a problem known as adverse selection
Provisions can be written into an insurance contract. But the insurer cannot enforce a contract about how fast you drive or whether you drive after having a drink. These are actions that are hidden from the insurer because of the asymmetric information: you know these facts but the insurance company does not. This is a problem of moral hazard similar to the one of labour effort. They are both principal agent problems: the agent (an insured person or employee) chooses an action (how careful to be or how hard to work) but cannot be included in the contract because it is not verifiable
In the moral hazard case the insured person (the agent) decides how much care to take. Taking care has an external benefit for the insurer (principal) but is costly for the agent, so consequently we have a market failure: the level of care chosen is too low
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Unit 7
The fundamental problem in the case of credit is that because the borrower may not repay the loan in the event of a failed project, she will take risks that she would have avoided if she had to bear the full cost of a bad outcome. This means that the project is more likely to fail, imposing costs on the lender. This will make the lender more reluctant to make loans unless the borrower can be given an incentive not to take undue risk, either by investing some of her own funds in the project for which she is seeking funding (equity) or by providing collateral to the lender. This means that a person with little wealth may not be able to get a loan.
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Borrowing and lending is a principal-agent problem in which the prudent use of the borrowed funds, hard work to ensure the success of the project for which the funds were borrowed, and the repayment of the loan cannot be secured by means of an enforceable contract. As a result, the decisions of the borrower have external effects on the lender. What the borrower does affects the profits of the lender but is external to the contract
Thus poor borrowers may be credit constrained or credit excluded. This is another form of market failure which arises particularly when wealth is very unequally distributed. Credit market failures also occur for another reason. When a bank makes a loan, it takes account of the possibility that it may not be repaid: if the interest rate it can charge is sufficiently high even quite risky loans may be a good bet
If the owners of the bank would bear all of the costs of a bankruptcy then they would make strenuous efforts to avoid it. But the owners are unlikely to bear the full costs for two reasons:
- The bank will typically have borrowed from other banks
- Too big to fail
Like environmental spillovers, excess risk-taking by banks and borrowers is a negative external effect leading to market failure
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Unit 8
Those who wish to limit the extent of the market often make two arguments:
- Repugnant markets: Marketing some goods and services - vital organs or human beings - violates an ethical norm or undermines the dignity of those involved
- Merit goods: it is widely held that some goods and services should be available to people independently of their ability or willingness to pay
Some kinds of activities are better carried out by families, some by governments, some by firms and some by markets