EC 100 Week 2 LT

1. EC 100 Week 2 LT

2. Last Micro Class Exercise • This week: Public goods / Externalities. • The result that decentralised markets with profit maximizing firms and utility maximising individuals maximises social welfare relies on the assumption that there are no externalities. • In case of externalities, the private benefit != social benefit. • Some examples: negative externalities, such as pollution. • Positive externalities: positive network externalities in social networks (Linked In, Facebook,…)

3. Last Micro Class Exercise • This week: Public goods / Externalities. • Public goods: non rival in consumption and non-excludable

4. Question 1

5. Question 2 • Positive externalities: the more individuals get vaccinated, the more useful is the vaccination to all others. • In competitive market, individuals only act “selfishly” (assumption). So don’t consume enough. • Government can encourage them to consume more, e.g. lowering price, making it compulsory. • In this case, the Marginal Benefit is increasing in the number of consumers (# of individuals vaccinated).

6. Question 3 • Tube ride: you make life more uncomfortable for everyone else • Why is c) not a negative externality?

7. Question 4 • No assigned property rights – and if they belong to the state, property rights need to be enforced for them to be effective. • Elephants are like a common pool resource • Poachers don’t face a cost of killing elephants in the way that farmers do

8. Similar example in lecture.

9. Question 5 • In exam – start with a definition! • Non-rival, non-excludable • Aside: Excludability is determined by the level of technology!

10. Question 6

11. Question 7 • Moral hazard occurs when there is asymmetric information (or more generally, imperfect information) • “Moral hazard occurs when the behaviour of one party to a contract cannot be trusted to carry out the terms of the contract” • i.e. the person carrying out the contract is not perfectly monitored. May act “immorally”.

12. Question 8

13. Question 9 Suppose the government insists that profit-maximizing insurance companies charge the same price for everyone to be insure themselves against the risk of loss from an earthquake.  It then finds the price is very high and take-up very low.  Why has this happened? What is adverse selection?

14. Question 9 Suppose the government insists that profit-maximizing insurance companies charge the same price for everyone to be insure themselves against the risk of loss from an earthquake.  It then finds the price is very high and take-up very low.  Why has this happened? What is adverse selection? Only sellers of poor quality products (e.g. in used car market), or high risk individuals (e.g. in insurance markets) stay in the market. Because of asymmetric information, it is not possible to tell what “type” of person someone is. (If sellers and buyers could tell, the market would work normally). This lack of information drives up prices and the market may collapse completely. Classic example is the used car market – George Akerlof (former LSE professor) won Nobel prize for “analysis of markets with asymmetric information”

15. Question 9 • A profit maximising insurance company must cover its costs Profit = Q*(P-AC) • The (main) cost is money paid out in insurance claims • In locations with low risk, people will not pay a high price for insurance cover • If the firm has to charge a uniform price, they will not buy insurance • This means that only people in high risk areas buy insurance • i.e. “adverse selection”…only high risk people are in the market • This drives up average costs, which drives up prices… • This higher price reduces take-up even further, for the “low exposure” individuals in the higher risk areas and so on…

16. Question 10 • Excludable: can exclude certain people (e.g. high risk groups / individuals) • Rival: there is a limited number of doctors/ nurses… • So by that definition, healthcare is not a public good. • But in general, there are positive externalities