Market Failure & Government

Adverse selection occurs when asymmetric information leads undesirable participants to dominate a market before a transaction takes place.

Asymmetric information exists when one party in a transaction knows more than the other, which can lead to market inefficiency.

The Coase theorem holds that if property rights are clear and bargaining is costless, private parties can negotiate to fix externalities efficiently.

An externality is a cost or benefit imposed on a third party who is not directly involved in the production or consumption of a good or service.

The free-rider problem occurs when people benefit from a good without paying for it, leaving it underprovided by the market.

The Gini coefficient is a numerical measure of income or wealth inequality ranging from 0 (perfect equality) to 1 (perfect inequality).

The Lorenz curve is a graphical representation of income or wealth distribution within a population, comparing actual distribution to perfect equality.

Marginal social benefit is the total benefit to society from consuming one more unit, equal to private benefits plus external benefits.

Marginal social cost is the total cost to society of producing one more unit, equal to private costs plus external costs.

Market failure is a situation where a market does not efficiently allocate resources, leading to a loss of economic efficiency.

Moral hazard occurs when one party takes greater risks because they do not bear the full consequences of those risks, often due to insurance or government protection.

A negative externality is a cost imposed on a third party who is not part of a market transaction, such as pollution.

A Pigouvian tax is a tax on a good with a negative externality, set equal to the external cost to restore the efficient quantity.

A positive externality is a benefit enjoyed by a third party not involved in a transaction, such as vaccination or education.

A private good is both excludable and rival: people can be prevented from using it, and one person's use reduces what is left for others.

A progressive tax is a tax system in which the tax rate increases as the taxpayer's income increases.

A proportional tax is a tax system in which the tax rate remains constant regardless of the taxpayer's income level.

A public good is non-excludable and non-rival: no one can be excluded from it, and one person's use does not reduce another's.

A regressive tax is a tax system in which the tax rate decreases as the taxpayer's income increases, placing a higher relative burden on lower-income individuals.

The tragedy of the commons is the overuse and depletion of a shared resource that is rival but non-excludable and owned by no one.

Marginal-cost pricing regulates a monopoly by forcing price down to where demand meets marginal cost (P = MC), the allocatively efficient 'socially optimal' output.

A fair-return price regulates a natural monopoly at the point where price equals average total cost (P = ATC), so the firm earns zero economic (normal) profit.