Econ Unit 2

Solutions to the externality problem rely on

"internalizing the externality":

MR=

= P−ΔP×Q. Due to the discount effect, MR<P MR curve lies below the firm's demand curve, by the amount equal to the discount effect. Discount effect is bigger when you sell a larger quantity (ΔP×Q) Gap between demand curve and MR curve widens as the quantity increases. MR curve declines more sharply than firm's demand curve.

fair bets

A gamble that, on average, will leave you with the same amount of money.

Problems with private bargaining

Bargaining costs need to be low Private bargaining is most successful when the benefits from solving the externality problem are high and the cost of bargaining are low But when bargaining is difficult, externalities remain a problem

behavioral economics:

Behavioral economics is economic analysis that includes psychological factors in assessing how people make economic decisions

The Burden of Taxes

Both buyers and sellers bear the economic burden of a tax.

Why do buyers ignore marginal external benefits when making decisions?

Buyers don't enjoy the marginal external benefits

Coase Theorem

If bargaining is costless and property rights are clearly established and enforced, then externality problems can be solved by private bargains.

Facts about public goods

Just because the government provides something, it doesn't mean that it is a public good. Gov't provides many goods that are not public goods, because they are actually excludable, rival, or both. Just because something is a public good doesn't mean that the government should fund it. It all depends on the social benefits vs. social costs. Values may differ. This leads to big political debates. Just because the government should fund a public good doesn't mean that the government should provide it.

External benefit

a benefit accruing to bystanders

Calculate marginal revenue _______

as the change in total revenue from selling one more unit. Use your firm demand to calculate marginal revenue

New entrants will always be at a

cost advantage vs. the incumbent.

firm demand

is the quantity demand from your firm

Price elasticity measures

responsiveness of quantity (demanded or supplied) to changes in price.

Risk Reduction Strategies

risk spreading diversification insurance hedging gathering information

Tax revenue= ?

tax amount * quantity

When do buyers bear less of the economic burden?

when demand is relatively elastic. They can buy something else instead.

3 step process to analyze externalities

1. Predict the equilibrium outcome to forecast what you think will happen 2. Assess what externalities are involved 3. Figure out what outcome is in society's best interests, then compare this to the equilibrium forecast

Rival good

A good for which your use of it comes at someone else's expense. When goods or services are rivals and it's easy to exclude those who don't pay, there's no free-rider problem.

Club good

A good that is excludable but nonrival in consumption. Try to figure out how to exclude people. Club goods are like local monopolies, which results in higher price and lower quantity than socially optimal

hedging

A hedge is an offsetting risk. Hedging therefore reduces risk by acquiring offsetting risks.

Quota

A limit on the maximum quantity of a good or service that can be sold. When a quota is binding, it requires the quantity to be less than what it would be at the supply-equals-demand equilibrium. Increase Efficiency by Allowing Trading

Quota

A limit on the maximum quantity of a good that can be sold.

Binding mandate on sellers vs. buyers

A mandate is binding if without it the equilibrium quantity would be lower. Binding mandate on buyers increases quantity buyers demand Binding mandate on sellers increases quantity sellers supply Either way, quantity increases

Natural Monopoly:

A market in which it is cheapest for a single business to service the market. Occurs when the marginal costs for a big company are less than they would be for multiple smaller companies.

Price Ceilings

A maximum price that sellers can charge.

Quantity Regulations

A minimum or maximum quantity that can be sold

Price floor

A minimum price that sellers can charge.

Binding price ceiling

A price ceiling that prevents the market from reaching the market equilibrium price. The highest price sellers can charge is set below the equilibrium price.

Binding price floor

A price floor that prevents the market from reaching the equilibrium price. The lowest price that sellers can charge is above the equilibrium price.

Cap and trade

A quantity regulation implemented by allocating a fixed number of permits, which can then be traded.

Mandate

A requirement to buy or sell a minimum amount of a good

Corrective tax (Pigouvian tax)

A tax designed to induce people to take account of the negative externalities they cause. Imposing a per-unit tax equal to the marginal external cost will lead people to make choices as if they're accounting for the marginal external costs of their actions

anchoring bias

Anchoring bias leads to excessive focus on an initial estimate. Anchoring bias is the tendency to begin with an anchor, or starting point, and insufficiently adjust from there. First impressions matter

Tragedy of the commons

Collective selves needs to be used when trying to fix the tragedy of the commons

Rival Good→

Common Resources→Negative Externalities & Overproduction

Governments regulate markets through two sets of laws:

Competition policy: set of laws that ensure markets remain competitive Anti-collusion Laws: goal is to prevent businesses from agreeing not to compete. Collusion: An agreement to limit competition. Creates market power because it allows the businesses to act as if they are monopolists Merger Laws: Goal: To prevent competing businesses from combining to consolidate market power. 2 potential effects of mergers: Mergers could create cost savings, which will feed into lower prices. Merger creates market power because companies don't need to undercut each others' prices to win customers Mergers can benefit or harm society

Cap-and-trade vs. corrective tax (pretty similar)

Corrective tax raises the direct financial cost of producing Cap-and-trade raises the opportunity cost Under either scenario, something becomes more costly (either paying more tax or foregoing revenue from selling your permit). Supplier act as if they're considering the marginal external costs of their actions Both systems attempt to harness the power of the market to solve externality problems Choice between the two depends on the knowledge you have: do you know the marginal external costs or do you know the socially optimal quantity?

diversification

Diversification: reduces risk by combining a large number of small risks whose outcomes are not closely related. Reducing reliance on any one bet working out, so your overall outcome is less risky. Shouldn't put all your eggs in one basket

Principles for Identifying the Right Solution

Don't intervene if you don't have to. Complementing market forces is better than hindering them. The right tool depends on what you're uncertain about (i.e. marginal external costs/benefits or socially optimal outcomes) Consider costs and benefits of regulations or public goods. Target outcomes, not specific processes. Ensure there's an incentive to innovate.

expected utility equation

Expected utility = Probability of outcome 1 x Utility of outcome 1 + Probability of outcome 2 x Utility of outcome 2 + ...

focusing illusion

Focusing Illusion: the tendency to mis-predict your utility by focusing on a few factors at the expense of others can lead you to mis-predict your happiness.

Side payments

If someone else's actions harm you, you can pay them to do something else instead.

Quantity Regulation

If the regulation isn't binding, it won't affect market outcomes... You need to find the price for the quantity Based on supply and demand Quota on Sellers: what buyers are willing to pay for the limited quantity available Quota on Buyers: what suppliers are willing to accept in return for providing restricted quantity

Conflict between private and social interests when...

If your choices affect bystanders (externalities) This can lead to market failures

Gap between marginal costs & price =

Incentive to find a way around the regulation

gathering information

Information is valuable to risk-averse people because it reduces uncertainty. The less uncertainty there is, the less risk you face. The value of information is greater the more it reduces uncertainty, the higher the stakes involved in the decision. Unfortunately information gathering can be costly (or impossible)

insurance

Insurance is a promise of compensation if a bad thing happens. The price of insurance is the premium Risk-averse people should buy actuarially fair insurance An actuarially fair insurance policy is a policy that, on average, is expected to pay out as much in compensation as it receives in premiums.

Affects and consequences of a price floor

It raises prices and lowers the quantity sold. When a price floor is set below equilibrium price, there is no effect... Quantity supplied > quantity demanded= surplus Sellers may try to sell their products illegally at lower prices (black markets) Sellers exit the market

loss aversion

Loss Aversion: is the tendency to be more sensitive to losses than to gains Loss aversion can make you sensitive to how a situation is framed. People are about twice as sensitive to losses as to gains

Unintended consequences of a price ceiling

Lower quality Lower maintenance Development of a secondary market for resale (black markets) Bribes/finder's fees Queuing

Sources of market power

Many competitors → few competitors (oligopoly) → No competitors Identical product → differentiated product (monopolistic competition and some oligopolies) → unique product

What is the relationship among marginal revenue, marginal cost, and price in a firm with market power?

Marginal cost = Marginal revenue < Price

types of marginal benefits

Marginal private benefit: the external benefit form one extra unit enjoyed by the buyer (equal to the individual demand curve) Marginal external benefit: the extra external benefit from one extra unit

types of marginal costs

Marginal private cost: the extra cost from one extra unit paid by the seller (equal to the individual supply curve) Marginal external cost: the extra external cost from one extra unit

Five Key Insights into Imperfect Competition

Market power allows you to pursue independent pricing strategies. Having more competitors leads to less market power. Successful product differentiation gives you more market power. Imperfect competition among buyers gives them bargaining-power. Your best choice depends on the actions that other businesses make.

the underproduction problem.

Market power leads businesses to produce a lower quantity and sell at a higher price

Comparing the outcomes of market power and perfect competition leads us to four important lessons:

Market power leads to higher prices: Market power price is higher than the marginal cost. Under perfect competition: p=MC. Therefore, market power increases prices. Companies with market power face a trade-off between larger profit margin vs. selling larger quantities. As a result, many businesses end up deciding on a big profit margin on those customers who will pay a high price, even if this means losing customers who can't pay as much. Market power leads to inefficiently smaller quantities.: Higher prices means fewer buyers will buy the product. Quantity demanded will be smaller: QMP<QPC With market power, the demand curve lies above the marginal cost curve. But the demand curve measures the buyer's marginal benefits. So the MB>MC. We have underproduction. With perfect competition, businesses produce until MB = MC. Market power leads managers to supply less because of the discount effect Reluctant to lower prices, because they'll get less revenue from existing customers. Under perfect competition, each business can sell whatever quantity they want at the market price and don't need to offer discounts to boost sales. Market power yields larger economic profits. On a per-unit basis, profit margin = price- average costs of production. Market power & price > average costs= positive profit Businesses with market power could theoretically produce at the perfect competition outcome, but they choose not to. The high-price, low-quantity outcome from market power is more profitable. Businesses with market power can survive even with inefficiently high costs. Profitability conferred by market power leads businesses to feel less pressure to adopt cost-saving measures. In the long run, if perfectly competitive businesses are inefficient, they will make a loss and exit the market. A profitable but inefficient monopoly can stay around for a while. Market power leads businesses to... charge a higher price, sell a smaller quantity, earn large profits and survive with inefficiently high costs.

Does it matter who gets the subsidy?

No it is divided between the sellers and buyers based on the elasticities of supply and demand

Does private bargaining require any government intervention?

No, not under the coase theorem. But it only holds in certain instances...

Are price changes side effects of an externality?

No, price changes are not side effects but are the whole focus of externalities (they are mechanisms by which markets work)

Public goods

Nonrival goods afflicted by the free-rider problem.

Different types of market structure:

Perfect competition Monopoly Oligopoly monopolistic competition

Spectrum of market power

Perfect competition (least market power) → Imperfect competition (monopolistic competition and Oligopoly) → Monopoly (most market power)

Which has the most market power? The least market power?

Perfect competition (least) Monopoly (most)

perfect competition

Perfectly competitive markets are markets in which: All businesses in an industry sell an identical good There are many sellers and many buyers, each of whom is small relative to the size of the market. Sellers have no market power. If you try to raise your prices above market levels, you'll lose all your customers to rivals. There is no point in charging less than the market price; it would only lower your margin. Your best option is to be a price-taker (follow the market price). In reality, all markets involve some form of competition, but true perfect competition is pretty rare.

What affect do price ceilings have?

Price ceilings lower prices but cause shortages. Quantity Demanded > Quantity Supplied= shortage When a price ceiling is set above the equilibrium price, there is no effect...

Define Price Gouging

Price gouging occurs when there are temporary price increases at moments of high demand (i.e. weather emergencies)

What can private bargaining do?

Private bargaining can restore the socially optimal outcome, because side payments act as a mechanism to internalize the externality.

Nonrival Good→

Public Good→Positive Externalities & Underproduction

Consequences of Quotas

Quantity is reduced (intended effect) With only a limited quantity available, buyers are willing to pay more for the product. Sellers would be willing to sell for less. But competition amongst buyers for scarce goods leads them to pay higher prices

Arguments in Favor of Anti-Price-Gouging Laws

Raising prices only benefits businesses, because businesses are limited to whatever inventory they have on hand. Supply is inelastic. Price gouging hurts the poor the most, because they are least able to purchase necessities at higher prices.

Price is determined by...

Regulation

Representativeness Bias

Representativeness bias leads you to overemphasize similarity. Representativeness bias is the tendency to assess the likelihood that something belongs in a category by judging how similar it is to that category.

Price Ceiling Laws:

Set price = Marginal cost. Eliminates the discount effect and the underproduction problem Price ceilings reduce economic surplus in a perfectly competitive market (increase surplus in an imperfect competitive market)

steps in calculating marginal revenue

Step 1: Calculate Total Revenue (price x quantity sold) Step 2: Assess Marginal Revenue (change in total revenue from selling 1 more unit) Step 3: Plot results to get the marginal revenue curve

A Three-Step Recipe for Evaluating Taxes

Step 1: Is the supply or demand curve shifting? Any change affecting buyers or their marginal benefits will shift the demand curve. Any change affecting sellers or their marginal costs will shift the supply curve. Step 2: Is the shift an increase or decrease in taxes? An increase in taxes will shift the curve to the left A decrease in taxes will shift the curve to the right Step 3: How will prices and quantities change in the new equilibrium? Compare the pre-tax and post-tax equilibria. there will be 2 post-tax prices: one for buyers and one for sellers.

Setting Prices and Quantities steps

Step 1: Keep selling until your marginal revenue equals your marginal cost (MR=MC). Remember that the Rational Rule for Sellers tells us to sell one more item if the marginal revenue is greater than (or equal to) marginal cost. This determines the quantity you should sell. Step 2: Set your price on the demand curve. Not on the marginal revenue curve! Once you've found where marginal revenue cuts marginal costs, look down to see the quantity and look up to find your best price (on the demand curve).

Types of Private bargaining

Strategic investments Mergers: When there are externalities across different markets, it is profitable for a business to operate in each market so that HQ can decide to internalize all externalities centrally.

firm demand curve

Summarizes the quantity that buyers demand from an individual firm as it changes its price.

Why do suppliers ignore external costs when making supply decisions?

Suppliers don't explicitly pay external costs

2 Styles of Thinking

System 1: "thinking fast" Intuitive thoughts; fast, effortless, automatic Rough but often accurate rules-of-thumb System 2: "thinking slow" Slower, deliberative, logical self, using methodological style of thinking that requires cognitive effort

The economic burden

The burden created by the change in after-tax prices faced by buyers and sellers.

Tax incidence

The division of the economic burden of a tax between buyers and sellers. depends on the price elasticity of demand and supply.

Output & Discount Effects: Marginal revenue lies below the demand curve.

The output effect is the revenue increase from selling one more unit. Output effect = P The discount effect is the revenue loss from cutting the price on all the units sold. To sell one unit for cheaper, you need to lower the price on all your units sold. Discount effect = ΔP×Q

Imperfect competition

The situation of facing at least some competitors and/or selling products that differ at least a little from those of competitors.

How do taxes shift demand?

The tax shifts the demand curve to the left, to reflect the lower willingness to pay for goods in the presence of a tax.

What does a tax do to the supply curve?

The tax shifts the supply curve to the left (represents an increase in marginal costs)

Arguments Against Anti-Price-Gouging Laws

These laws set a price ceiling and lead to a decrease in supply & increase in demand- creating a shortage Panic-buying Allowing prices to rise will increase quantity supplied (higher prices will be an incentive for businesses) Most of these really center around whether price elasticities of demand/supply are elastic or inelastic...

Fix the price: Corrective taxes and subsidies (main idea)

To use taxes and subsidies to "correct" the market price in a way that leads people to internalize the marginal external costs and benefits of their actions

Whichever factor is more elastic bears less of the economic burden of a tax (true or false)

True

Diminishing Marginal Utility:

Utility is your level of well-being. When making choices, you should really consider utility rather than money. Utility is related to wealth; greater wealth enables you to make choices that will make you happier and enjoy more utility. So generally more wealth à more utility. Marginal utility is the additional utility you get from one more dollar. Highest when you are poor and declines as your wealth grows Diminishing marginal utility is the idea that each additional dollar yields a smaller boost to your utility-less marginal utility-than the previous dollar. makes you risk averse

Free-rider problem

When people cannot be easily excluded from using something, a particular kind of externality problem called the free-rider problem can occur. A situation that arises when someone can enjoy the benefits of a good without bearing the costs.

Nonexcludable

When someone cannot be easily excluded from using something When you can't exclude (non- excludability) nonpayers from using a good, there will be externalities.

Non-rival goods and how they play a role in positive externalities

Whenever there are bystanders who benefit from an action without contributing ( nonexcludable good), and when their benefits don't subtract from anyone else's (nonrival good), a positive externality results With nonrival goods, free-riders enjoy positive externalities without hurting others

expected utility

Whenever you are deciding whether to take a risk, your decision depends on 3 factors: Size of the risk relative to the reward Whether the stakes are high or low Your degree of risk aversion You should choose the options with the largest expected utility. Your expected utility measures what your utility will be, on average, if you make a particular choice. If you follow this rule, your decisions will, on average, yield a higher level of well-being.

Overconfidence:

You are probably overconfident. Overconfidence is the tendency to overrate the accuracy of your forecasts.

The Risk-Reward Trade-Off:

You don't want to eliminate all risk. If you eliminate all risk, you eliminate opportunities for good outcomes. There is a trade-off between risk and reward. Take risks when the benefits exceed the costs (in terms of utility). The greater the reward, the more willing you should be to make a risky investment. Unfortunately, there is a positive correlation between risk & reward.

Price Regulation

You need to find the quantity sold at the new price Based on supply & demand Price Ceiling: quantity supplied Price Floor: quantity demanded

External cost

a cost imposed on bystanders

Nonrival good

a good for which one person's use doesn't subtract from another's.

Common resource

a good that is rival and also non excludable. Private gains but shared costs.

what do taxes represent?

a marginal cost to sellers (additional cost paid for each unit sold) a decrease in marginal benefits to the sellers, because now each purchase comes with a tax obligation.

A competitive merger creates

a more fearsome competitor. Bad for rivals. Could be good for consumers

Subsidies

a payment made by the government to those who make a specific choice. A subsidy is basically a negative tax: increasing quantity, reducing prices buyers pay and increasing prices sellers receive.

a price change is

a redistribution between buyers and sellers (not an externality)

Risk Aversion

a risk averse individual will find that the cost to their wellbeing actually exceeds the benefits to their wellbeing here. You're not just looking at the financial costs & benefits; you're considering the costs and benefits for your well-being.

Risk is

a set of probabilities and payoffs

Externalities

a side effect of an activity that affects bystanders whose interests aren't taken into account Can lead to market failures, or inefficient outcomes not in society's best interest

Tragedy of the Commons

a tendency to over consume a common resource When it costs nothing to graze sheep on the commons, each shepherd does a lot of it. This results in tragedy: commons will be overgrazed and grass will not grow back. The tragedy exists because everyone would be better off if we could agree to limit consumption of common resources...

patents

a trade-off between underproduction and innovation.

Social interests

all costs and benefits in society, not just an individual's

Marginal social benefit

all marginal benefits, no matter who gets them Marginal social benefit= marginal external benefit + marginal private benefit (demand curve)

Marginal social cost

all marginal costs, no matter who pays them

Factors to describe the structure of your market and determine the extent & type of competition=

amount of competitors, expected new competitors?, are your products exactly the same as your competitors? Are you offering different goods, better service, or higher-quality products?

Positive externalities

an activity whose side effects benefit bystanders Generate benefits for others Bystanders do less of these socially useful activities that is in society's best interest

Negative externality

an activity whose side effects harm bystanders Negative externalities impose costs on others People often make decisions without thinking about their negative effect on others, therefore doing more of these activities than would be in society's best interest

most market power:

as the only seller in the market, you don't need to worry about competition, and the demand for your goods is equal to the market demand. Firm demand is the market demand curve Raising prices leads to small loss in sales, so firm demand is relatively steep (inelastic)

How to solve the tragedy of the commons

assign ownership rights/property rights Tragedy of the commons is an issue because when everyone owns something, they end up acting as if nobody owns it. Ownership rights help facilitate private bargaining *for non excludable rival goods aka common resource problems

Considerate action in exchange for a side payment leaves both sides...

better off. If someone else's actions benefit you, you can pay them to do (more of) it.

Private bargaining/ coase theorem

can sometimes solve externality problems. Main Idea: Get all the interested parties in a room (including the bystanders) and give them an opportunity to negotiate with each other.

Public goods can be provided by ______

communities

Private interests

cost and benefits an individual occurs

buyers and sellers are

decision makers not bystanders Potential buyers take into account their own interests when deciding whether or how much to buy Potential sellers take full cont. of their own interests when deciding what price to accept = they CANNOT be bystanders

The statutory burden of a tax

describes the burden of being assigned by the government the responsibility of sending a tax payment.

Positive externalities create

external benefits

Negative externalities create

external costs

Company rules target...

externalities

Marginal costs

extra cost of producing one more unit

Corrective subsidies can

fix positive externalities

Problem with quotas and the solution

gov't can't easily identify which suppliers are efficient (and it's politically hard to set different caps for different businesses without favoritism or corruption getting in the way) Solution: Rather than impose fixed quantity caps for each individual business, the government can issue each business a number of permits, where each permit gives its holder the right to produce a certain quantity of output. Businesses can buy and sell—that is, trade—these permits

"Simple" solution to the under provision of a public good

government purchases public goods for everyone to use, paid for from tax revenues.

Socially optimal pollution

if we really understand externalities, we realize that it may be socially optimal to have some pollution. Why? If we eliminate pollution at no cost then it would be optimal but cutting pollution is costly. We are not just cutting pollution, but we are also cutting all activities that create pollution It's about finding the right balance

Most businesses operate in

imperfectly competitive markets

Increasing the reward _____ the utility of taking the risk. Increasing the risk aversion _____ the utility of taking the risk

increases decreases

Price is determined by ________

intersection of demand curve with maximum quantity

Risk spreading

is breaking a big risk into many smaller risks so that it can be spread over many people. Risk won't prevent a profitable investment from being made...as long as you can spread the risk thinly enough.

market demand

is the quantity demanded across all firms.

Individual demand

is the quantity demanded by a single buyer.

why is market structure important?

it shapes your market power The structure with the least market power is perfect competition At the other extreme, monopolists have the most market power because they're the only businesses selling a unique product. Both perfect competition and monopoly are rare. Competitors rarely sell completely identical products Once you broaden your market definition, everybody faces some competition.

availibility bias

leads you to overestimate vivid and easily recalled outcomes. Availability bias is the tendency to overestimate the frequency of events that are easily recalled and underestimate the frequency of less memorable events.

The demand curve=

marginal benefit curve

Demand (buying) decisions are guided by

marginal benefits

supply curve = ?

marginal cost curve

Supply decisions are guided by

marginal costs

Marginal social cost=

marginal external cost + marginal private cost (supply curve)

marginal social benefit=

marginal social cost

The externality problem

market forces often yield good outcomes for buyers and sellers, but with externalities, there is another set of stakeholders to consider= the bystanders. Market focus ignore the effect on bystanders, leading to inefficient outcomes

Problem with market power:

market power distorts market forces, which can lead to worse outcomes. Sellers exploit their market power.

Monopolistic Competition

markets are markets in which many small businesses compete, each selling differentiated products Product differentiation is an effort by sellers to make their products different from those of their competitors. The more distinct your product, the less your rival's products will be a close substitute. Differentiation based on type of good, brand image, quality, location, customer service, return policies, packaging, etc. The sellers have some market power.

Monopoly

markets in which there is one seller The seller has a lot of market power Can raise prices without losing customers to your competitors (because there are none)

Oligopoly

markets with only a handful of large sellers (results in strategic battles for market share) With a handful of rivals, their decisions can have a big impact on your bottom line. Your best choices depend on how your rivals respond; their best choices depend on how you'll counter. The sellers have some market power. If one company raises its prices, it will lose some but not all customers.

Problem with monopolists and the solution

monopolists don't set p=MC (society's best interest) Solution(s): Government sets p=MC But then the natural monopoly could make a loss. P covers the marginal cost of the last unit produced. If MC of the rest of the output is higher, price won't cover those costs Suppliers can stay in business only by offering prices that are too high. Government provides services directly, using tax revenue to pay for the losses

The best way to avoid a tax

not to buy/sell things that are taxed. Or to buy/sell less of these things.

Which market structure has the flattest firm demand curve, all else equal?

perfect competition

There's a trade-off between

price and quantity: selling a large quantity of items vs. making more money on each item. Use your firm demand curve and the marginal revenue curve to evaluate this trade-off.

Profit margin=

price- average costs

Rational rule for society

produced more of a product as long as its marginal social benefit is at least as large as the marginal social cost

Total profit=

profit margin x quantity

An anticompetitive merger

reduces competition for all sellers. Good for rivals, Bad for consumers. To see if a merger hurts consumers, figure out if it helps rival firms.

Quantity is determined by...

regulation

Rational rule for sellers

sell one more item if the price is greater than (or equal to) the marginal cost

People make predictable mistakes when assessing probabilities & payoffs. This is because of a reliance on

snap judgments vs. reasoned consideration.

Corrective taxes can....

solve negative externalities

What does a tax on buyers affect?

the demand curve because sellers post the price they will receive without the tax. Buyers must pay this price to the seller plus the tax

Market Power

the extent to which a seller can charge a higher price without losing many sales to competing businesses. The more market power you have, the higher the price you can charge.

Socially optimal outcome

the outcome that is most efficient for society as a whole, including the interests of buyers, sellers and bystanders

what are externalities about?

the side effects on people whose interests aren't taken into account

When the government sets a quota it has to determine

the socially optimal quantity for the whole market to produce and how much each individual supplier is allowed to produce

What does a tax on sellers affect?

the supply curve (buyers will pay whatever price the seller posts, but they aren't directly responsible for paying the tax). The seller keeps what the buyer pays minus the tax

Type of externality depends on...

the type of good

The Golden Rule is about externalities

to do unto others as you would like them to do unto you Take account of how your actions affect other people. Rules are a very blunt instrument.

Average costs=

total costs/ quantity= fixed costs/ quantity + variable costs/quantity

Average revenue=

total revenue/ quantity= price

When do sellers bear less of the economic burden?

when supply is relatively elastic. They can produce something else instead

type of externality depends on ________

whether when you use the good, you are actually harming me (rivalry)

Least market power:

with no market power, raising your price a penny above the market price means you'll sell nothing. Lower it a penny and you'll sell a huge quantity. Basically a flat demand curve Raising your prices will sharply reduce your quantity, so firm demand is relatively flat (elastic).

some market power

you have some market power, and hence a higher price will lose some, but not all customers. Similarly, a lower price will gain some, but not all customers. A downward-sloping firm demand curve

The firm's demand curve is also

your average revenue curve

what does market power shape

your firm's demand curve