Government Economic Service (GES) Assessment Centre Microeconomics for Policy Analysis Flashcards

24 sample cards from the Microeconomics for Policy Analysis deck

Sampled from the end of the deck, so these are different cards from the ones shown on the syllabus page.

1. List the main types of barriers to entry.

   Structural barriers (economies of scale, high sunk/capital costs, control of key inputs, network effects), legal barriers (patents, licences, regulation), and strategic barriers (limit pricing, predatory pricing, brand proliferation).

2. Define a negative externality and state its efficiency consequence.

   A negative externality is a cost imposed on third parties not reflected in market prices (e.g. pollution). Because marginal social cost exceeds marginal private cost, the market over-produces relative to the efficient level, creating deadweight loss.

3. What is a Pigouvian tax and what is its optimal level?

   A Pigouvian tax corrects a negative externality by taxing the activity. The optimal tax equals the marginal external cost at the efficient output, so $MSC = MSB$, internalising the externality.

4. State the Coase theorem and its key condition.

   If property rights are well defined and transaction costs are negligible, private bargaining will achieve an efficient allocation regardless of who holds the rights. High transaction costs or many parties undermine this result.

5. Define the two defining characteristics of a pure public good.

   Non-rivalry (one person's consumption does not reduce availability to others) and non-excludability (you cannot prevent non-payers from consuming). Examples include national defence and street lighting.

6. Explain the free-rider problem.

   Because public goods are non-excludable, individuals can enjoy them without paying, so each understates their willingness to pay. This leads to under-provision or non-provision by private markets, justifying public provision.

7. Define adverse selection and give an example.

   Adverse selection is a pre-contract information asymmetry where hidden characteristics distort the market — e.g. in Akerlof's 'market for lemons', sellers know car quality but buyers do not, driving good cars out of the market.

8. Define moral hazard and contrast it with adverse selection.

   Moral hazard is a post-contract problem of hidden action: an insured or protected party changes behaviour because they no longer bear the full consequences. Adverse selection involves hidden information before the contract; moral hazard involves hidden action after it.

9. Name two market responses to information asymmetry.

   Signalling (the informed party credibly reveals quality, e.g. education or warranties — Spence) and screening (the uninformed party designs choices to sort types, e.g. insurance deductibles — Rothschild-Stiglitz).

10. Distinguish merit goods from demerit goods.

    Merit goods are under-consumed relative to the social optimum because consumers under-value private/external benefits (e.g. education, vaccination). Demerit goods are over-consumed because consumers under-value private/external harms (e.g. tobacco, alcohol).

11. What is government failure?

    Government failure occurs when state intervention produces a net welfare loss, leaving outcomes worse than the unregulated market — through information gaps, distorted incentives, regulatory capture, administrative costs, or unintended consequences.

12. Give two common sources of unintended consequences from policy intervention.

    Behavioural responses that offset the policy (e.g. moral hazard, the Peltzman effect), and distortion of incentives/prices (e.g. price controls causing shortages, subsidies encouraging over-production). Regulatory capture and rent-seeking are also key sources.

13. Define Pareto efficiency.

    An allocation is Pareto efficient if no one can be made better off without making at least one other person worse off. It says nothing about fairness — many Pareto-efficient allocations exist.

14. State the First Fundamental Theorem of Welfare Economics.

    Under competitive markets with complete markets and no externalities or market power, any competitive (Walrasian) equilibrium is Pareto efficient — the formal statement of Adam Smith's 'invisible hand'.

15. State the Second Fundamental Theorem of Welfare Economics.

    Any Pareto-efficient allocation can be achieved as a competitive equilibrium given an appropriate lump-sum redistribution of initial endowments, with convex preferences. It separates efficiency from distribution.

16. What is the equity-efficiency trade-off?

    Policies that redistribute toward greater equity (e.g. progressive taxes, transfers) can blunt incentives to work, save and invest, reducing efficiency. Okun's 'leaky bucket' captures the welfare lost in transferring resources.

17. Distinguish horizontal equity from vertical equity.

    Horizontal equity: people in equal circumstances should be treated equally (equal pay equal tax). Vertical equity: people in different circumstances should be treated appropriately differently (those with greater ability to pay should pay more).

18. What is a social welfare function?

    A social welfare function aggregates individual utilities into a single measure of society's wellbeing, $W = W(U_1, U_2, \dots, U_n)$, providing a basis for ranking allocations including their distribution.

19. Contrast the utilitarian and Rawlsian (maximin) social welfare functions.

    Utilitarian sums utilities, $W = \sum_i U_i$, valuing total welfare regardless of distribution. Rawlsian maximin, $W = \min(U_1,\dots,U_n)$, ranks society by the welfare of its worst-off member, implying strong redistribution.

20. What are distributional weights in policy appraisal?

    Distributional weights are multipliers applied to costs and benefits accruing to different income groups, giving extra weight to gains for poorer groups (reflecting diminishing marginal utility of income) so that appraisals account for equity, not just efficiency.

21. State the basic decision rule of cost-benefit analysis (CBA).

    Approve a project if the present value of its social benefits exceeds the present value of its social costs, i.e. net present value $NPV = \sum_{t=0}^{T} \frac{B_t - C_t}{(1+r)^t} > 0$ (or benefit-cost ratio > 1).

22. Why is discounting used in CBA and how does the discount rate affect appraisal?

    Discounting converts future costs and benefits to present values because resources have a time value (opportunity cost, time preference). A higher discount rate reduces the weight on distant future effects, disadvantaging long-term projects (e.g. climate).

23. What is the opportunity-cost principle and its role in CBA shadow pricing?

    Opportunity cost is the value of the next best alternative forgone. In CBA, market prices are replaced by shadow prices reflecting true social opportunity cost where markets are distorted (taxes, unemployment, externalities).

24. How is the value of a marginal change in welfare measured for non-market goods in CBA?

    By willingness to pay (WTP) for gains or willingness to accept (WTA) for losses, estimated via revealed-preference methods (e.g. hedonic pricing, travel cost) or stated-preference methods (e.g. contingent valuation).

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