Key Issues faced by Modern Firms
NOTES CHAPTER 3 - WARGLIEN
When the mill and the farmer negotiate an efficient agreement they are in effect
creating a market for exchanging property rights to a good.
Prior to their negotiation, a negative externality was present because those markets
didn’t exist. In fact, every externality can be traced to a missing market and private
negotiation remedies the externality by creating a market.
Why might two or more parties fail to address an externality through negotiation,
despite the promise of mutual benefit?
Many of these factors cause the market to fail and thereby to give rise to externalities,
which can also cause bargaining to break down.
1. Bargaining can be impractical and costly in terms of time and effort.
2. Assessment of property rights ca be ambiguous, based on conflicting legal
precedents: the owner of the mill may believe to have the right to pollute
whereas the farmer may believe to have to right to have clean water. In such a
cases the two parties might find themselves in a costly legal battle.
3. Limited information availability
4. Incomplete and so inefficient contracts may be difficult to enforce. In some
cases parties might not be able to monitor compliance with an agreement or
monitoring might by very costly
The conclusion of the “invisible hand of the market” promotes economic efficiency,
where each consumer’s well-being depends only on her own consumption and where
each firm’s output depend only on its own production decisions.
However, choices can profoundly affect the well-being of others. In such cases, the
competitive markets fail to allocate resources efficiently. Therefore, externalities
born: actions if these affect someone with whom the decision
Externalities are created by
maker is not engaged in a related market transaction. They can be negative if they
affect someone (pollution) or positive if they benefit someone else (public good).
- Someone that lights up a cigarette in a close and public place
- Abatement of pollution
- The consumer to decides to buy something and the seller who decided to
provide a service 2
NOTES CHAPTER 3 - WARGLIEN
When a consumption or production activity creates an externality, competitive
markets will usually allocate resources inefficiently.
When an externality is present the cost and/or benefit of an activity to the
party who performs it differ from the costs and/or benefits of that activity, which
include effects on other parties. In a competitive market each consumer purchases a
private MB = P.
good up to the point at which her therefore, a competitive equilibrium
ensures that private marginal benefit equals the private marginal cost.
social MB = social MC.
But from the social perspective, efficiency requires that If either
the consumption or production of the good creates negative externalities, then
equality between private MB and private MC will imply that social MB is < social MC.
From society’s perspective, that means a small reduction in the level of consumption
and production would increase welfare, so that level is too high. On the contrary, if the
consumption or production of goods creates a positive externality, the equality
between private MB and private MC will imply that social MC > social MC. So, an
increase in consumption or production would increase welfare, so the level is too low.
Public goods non-rival non-
Public goods are a positive externality. A public good is a good and
A good is non-rival if more than one person can consume it at the same time
without affecting its value to others.
A good is non-excludable if there is no way to prevent a person to consume it.
For example, national defence is a public good, because one citizen’s enjoyment of
national security doesn’t reduce the its value to others and because there is no way to
withhold the benefits of it from any particular person.
are present when one party has more information on the
characteristics of the good or service to be traded.
- Informed parties: used-car sellers, insurance buyers, workers;
- Uninformed parties: used-car buyers, insurance companies, employers;
adverse selection moral
There are two forms of information asymmetries: and
hazard. occurs when the informed party is more willing to trade when the
trading is less advantageous to a uniformed trading partner. Therefore, it results in a
market failure for high-quality products, because the uniformed party will
rationally lower his/her willingness to pay even further, so sellers of effectively high-
quality good will not be willing to sell at such low price.
occurs in settings with adverse selection when the
presence of unattractive trading partners drives attractive one out of the
market by altering the prices at which they can trade.
5 mesi fa
I contenuti di questa pagina costituiscono rielaborazioni personali del Publisher beatrice_fontana di informazioni apprese con la frequenza delle lezioni di Introduction to the Modern Firm 2 e studio autonomo di eventuali libri di riferimento in preparazione dell'esame finale o della tesi. Non devono intendersi come materiale ufficiale dell'università Ca' Foscari Venezia - Unive o del prof Warglien Massimo.
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