Chapter 8: Market Failure
1. Dorm noise rules, much like nighttime noise rules in residential neighborhoods, are good (and familiar
to students) illustrations of the issues involved in the attempt to deal with potential negative externalities.
2. Apartment damage deposits are a good illustration of using market contracts to prevent the costs of
damage (external costs) from being imposed on the owners, by making the tenants owners at the
3. Catalytic converters can be used as an example of regulation trying to deal with the free rider
problem. When they were originally offered, they were options that few people purchased. (why bear the
cost to clean up someone else s air?) Making them mandatory overcame the free rider problem ( I won t
clean up my own pollution ) in this case.
4. An interesting class discussion can be raised when talking about the external benefit argument for
subsidized education. Ask students how large the tuition subsidy should be (to get them to separate the
5. It can be a useful class exercise to ask students what efficiency would require in dealing with an
industry that produced both external benefits and costs. Would that imply the industry should be
subsidized or taxed? Get them to see that the answer depends on the relative magnitudes of the
externalities, as well as on income distribution considerations.
6. It is important to make clear to students that the textbook s discussion of solutions to externality
problems are attempts to mimic what a competitive private market would have generated if the property
7. It is worth noting that markets may internalize more externalities than commonly supposed (e.g., if
8. The problem of externalities came be used to talk about why morality matters in a society. After all,
the government cannot internalize all externalities effectively. Moral and ethical codes can often reduce
9. This is a good chapter to give students additional examples of unintended consequences (e.g., child
proof caps that actually increased accidental poisonings, because arthritis sufferers couldn t open them
10. A rich source of analogies that help students to understand the analysis of public goods and
externalities, particularly the free rider problem, comes from roommate problems. Whether one considers
11. The free rider problem can also be illustrated in a context very familiar to students by discussing the
difficulties associated with group projects or assignments.
12. Cleaning house, doing laundry and other household chores can be used as examples of the analysis
of trying to get public goods provided in a society.
13. A provocative question for classroom discussion is to ask whether the protection of property rights is
14. In talking about choices and information costs, one helpful illustration is to show that sometimes it is
cheaper to make mistakes than to be right. This is true whenever the costs associated with being wrong
15. A useful Illustration of some problems dealing with information is why rules exist against bypassing
the real estate agent (by exchanging the house directly between the buyer and seller with no agent) who
16. The issue of whether the government should use mandates or provide consumers more accurate
information so that they can choose more wisely when consumer information might be too limited
17. A good illustration of who can solve an informational asymmetry at the lowest cost is car transmission
warranties. The manufacturer accepts liability up to a certain period of time or number of miles, because
18. Another good example of asymmetric information and the lemon problem is that of online purchased
or free research papers. The user has far less information than the provider about quality (having not
19. A good example of moral hazard to use in class is a discussion of why there is no lunch insurance.
Since students will tend to eat lunch whether they are insured or not, there would be no real insurance
(risk or uncertainty reduction) involved. However, by lowering the marginal cost of added helpings or
higher quality food, it would dramatically increase the cost of food eaten (the moral hazard problem once
someone is insured).