Passage on Public Goods, Private Goods, and Market Efficiency

XAT 2015 · VALR · Medium · Reading Comprehension

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Passage / data set

For private goods, competitive markets ensure efficiency despite the decentralized nature of the information about individual's tastes and firm technologies. Implicitly, market competition solved adverse selection problems and the fixed - price contracts associated with exogenous prices solve moral hazard problems. However, markets fail for pure public goods and public intervention is thus needed. In this case, the mechanisms used for those collective decisions must solve the incentive problem of acquiring the private information that agents have about their preferences for public goods. Voting mechanisms are particular incentive mechanisms without any monetary transfers for which the same question of strategic voting, i.e., not voting according to the true preferences, can be raised. For private goods, increasing returns to scale create a situation of natural monopoly far away from the world of competitive markets. When the monopoly has private information about its cost or demand, its regulation by a regulatory commission becomes a principal - agent problem.

(Note: Public goods are those in which individuals cannot be excluded from use and where use by one individual does not reduce availability to others, while an individual can be excluded in case of private goods.)

Question 1 of 3

For which of the following goods, can markets not be efficient?

  1. A.

    Packaged water

  2. B.

    Electricity supply at home

  3. C.

    Air

  4. D.

    Petrol

  5. E.

    All of the above

Question 2 of 3

Which of the following cannot be concluded from the above paragraph?

  1. A.

    Public intervention is the panacea when market fails.

  2. B.

    Adverse selection problems as well as moral hazard problems may not arise in competitive markets.

  3. C.

    Strategic voting is nothing but a non-monetary incentive mechanism.

  4. D.

    Lack of access to private information regarding preferences of agent leads to incentive problem.

  5. E.

    Public regulations may address problems associated with natural monopoly.

Question 3 of 3

Read the following statement carefully:

Statement 1: In India factories dump their waste in the nearby water bodies.

Statement 2: Government is thinking of granting tax benefits to factories which adopt eco-friendly practices.

Which of the following options best captures the relationships between Statement 1 and Statement 2?

  1. A.

    Statement 1 is an example of market failure and Statement 2 corroborates Statement 1.

  2. B.

    Statement 1 is an example of 'adverse selection problem' and Statement 2 is an example of 'moral hazard problem'.

  3. C.

    Statement 1 is an example of market failure while Statement 2 suggests one way of reducing the problem.

  4. D.

    Statement 1 is an example of public good and Statement 2 is an example of private good.

  5. E.

    In Statement 1 the principal is 'factory' and in Statement 2 the principal is 'government'.

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