Question

a) The level of market efficiency at one point in time is called __________.

b) The by product of an activity that affects somebody else not involved in that activity is called __________.

Answer 1

a) The level of market efficiency at one point in time is calculated by Efficient Market Hypothesis (EMH). An efficient market is where potential competitors are competing for acquiring shares and all necessary information is available free to the public. Hence due to the active competition, at any point in time, the value of securities reflect the effect of information based on past events and those based on predictions for future.

Based on this, there are three distinct levels at which markets are efficient. Strong form where the current market price reflects all the available information (both private and public), but no investors will be able to consistently find the under valued stocks. Semi strong form where the current market price reflects the past process and the available public information. Weak form reflects that only past prices are available for the public and it won't be useful to get the actual technical analysis.

b) The by-product of an activity that affects somebody else not involved in that activity is called Externality. It is the cost or benefit that affects a third party without being reflected in the market prices. Here, the third party has no control over the cost or benefit and it can also be both positive or negative. It impacts the consumption and production possibilities of the unrelated party.

Most of the externalities are negative and that can only be reduced by taxation on those negatives or incentivising the positive externalities. It requires cooperation from both public and private sector.