ECON 10a Lecture Notes - Lecture 11: Cookie Monster, Free Rider Problem, Efficient-Market Hypothesis

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Market Failure with Public Goods
Dam for flood control
100,000 identical families, each are willing to pay 1,000 dollars to be done with
flooding
Social Benefit
Total benefit to society would by 100,000 x 1,000 dollars, which is 100M
$
Social Cost
70M dollars, the cost to build the dam
“ I, the undersigned promise to pay the contractor $ ----, once the dam is
finished” ---- sign
Each person feels that they won’t change the probability of the total
outcome
The private market finds it very hard to make a profit, or even break even
Free Rider Problem
Each familiy has an incentive to understate (to lie) hopping to take a free
ride on the contributions of other
This problem only exists because of non-exclusion, because once the good
is created, the person will benefit despite the amount they contributed
Most intense in a large group, 100,000
Ex. # 2
Four extremely wealthy people each willing to pay 25$ Mil. to be done with
floods
These folks have less incentive to lie, and they know that their
contribution represents a significant amount of the percentage the
contractor collects
Less incentive to understate
The free rider problem is smaller
Example Group Projects
Public Good
Grade
Slackers increase as the size of group increases
Externalities are present, the market fails to create the socially efficient quantity
When public goods are present the market fails to create the socially efficient Q
Appear to be two sources of Market Failure
Relationship btwn Public Goods and Positive Externalities
Ex. 3.
99,999 Ordinary families
1 very wealthy large landowner
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