Question

1. If a good has an externality do free markets markets maximize social welfare? Why or why not?

2. Suppose a politician proposes taxing a good. As an economist (trying to maximize social well-being), under what circumstances would you support the tax and why?

3. What is a market failure? Why is it important to study market failures?

4. Suppose a good is both non-rival and non-excludable. Do we expect the market to provide the desired amount of the good? Why or why not? If not, what can be done to reach the desired amount of the good?

Answer 1

Answer 1. If a good has externalities, free market may or may not be able to maximize social welfare. This is because of a good has positive Externality then producing more of that good will enable free market to maximize social welfare and if the good has negative externality then it may lead to market failure.

Answer 2 if the tax is imposed on the goods that produced negative externality, then an economist would support imposing tax. For example, if tax is imposed on a packet of ciggarette then it will increase prices and some consumersay stop buying it. This will decrease the demand and negative externality.

Answer 3. Market failure occurs when goods are unequally distributed and there is improper allocation of resources in the market. It is important to study market failure because it is important that a market has proper allocation of its resources. If there is no proper allocation, all these resources will either get under-used of get over-used. Both the situation will affect the availability of resources in the economy and can lead to permanent market failure  

Answer 4. When a good is non-rival and non-excludable it is said to be public good. In case of public good, a market is expected to produce desired amount of goods because public goods are used by all the people of the country and no one can be denied the right to use public good.