Module 6
What is a market failure?6.01
A situation in which the free-market system fails to satisfy society's wants (when the invisible hand doesn't work) -private markets don't efficiently bring about the allocation of resources
6.02 What is a negative externalitie?
Situation that results in a COST for a different person other than the original decision maker -the costs "spillover" to other people or society
6.02 What are spillover costs?
Situations that cause costs for people not involved in the economic transaction or decision are those that have spillover costs. Without regulation, they result in overproduction. An example of this could be pollution.
(6.03) Where should the government place the price ceiling?
Socially Optimal Price- P=MC (allocative efficient) OR Fair Return Price (Break-Even)-P=ATC (normal profit)
(6.03) In the early demonstration of power, the US Supreme Court in 1911 upheld the governments right to break up what?
The right to break up the Standard Oil, which had controlled about 90% of the country's oil refining into 34 independent firms.
Why doesn't the free market provide public goods? Why not?6.01
There is little opportunity to earn profit. Individuals benefit without paying
(6.03) What is price discrimination?
Where different customers are charged different prices for the same product
(6.04) What does welfare provide for citizens?
safety net (retirement, unemployment, workers health, etc.)
(6.04) What are Progressive Taxes?
these taxes take a larger percentage of income from higher income groups, the US federal income tax system is a good example of a progressive tax system.
(6.04) What is a proportional (flat) tax?
these taxes take the same percent of income from all income groups. Sometimes refereed to as a flat tax
6.02 What happens when a government imposes a per unit subsidy?
to increase the population of the good, lower the price to consumers, and help the market reach a socially optimal level again based on marginal social benefit and cost. Per unit, the subsidy would also remedy a deadweight loss.
(6.04) Why do economists use the Lorenz Curve?
to measure and illustrate income distribution in a given economy
(6.03) What are tied sales?
where purchase of one product commits the buyer to purchase some other product.
(6.03) What is a merger and acquisition?
where the outcome would be to "substantially lessen competition" in an industry
(6.04) The Gini Coefficient would be equal to.. (formula)
(area A)/ (area A + area B)
(6.04) Why does the government tax?
-Finance government operations for public goods-highways, defense, employee wages -Influence the economic behavior of firms and individuals-ex: excise taxes of tobacco raises tax revenue and discourages the use of cigarettes
What is the demand equal to? (Public goods)6.01
Demand is equal to the marginal benefit to society
What are examples of a Free Rider Problem?6.01
-people who download music illegally -people who watch a street performer and dont pay -people who benefit from services like police/fire
How can the government solve the problem of the Free Riders?6.01
-they can find new ways to punish/exclude free-riders -use tax dollars to provide the service to everyone
6.02 What are externalities?
-third person side effects -these are EXTERNAL benefits or external costs to someone other than the original decision maker
(6.03) When the government regulates a monopoly market, what two goals do they have in mind?
-to lower prices and increase output -note that both of these goals would occur in more competitive markets -In some cases, though (like the natural monopoly), a competitive market just will not exist on its own.
What is the free market? (capitalism) What are the 5 characteristics? 6.01
1. Little government involvement in the economy (Laissez Faire= Let it be) 2. Individuals OWN resources and determine what to produce, how to produce, and who gets it 3. The opportunity to make PROFIT gives people INCENTIVE to produce quality items efficiently. 4. Wide Variety of goods available to consumers. 5. Competition and self-interest work together to regulate the economy
(6.04) What kind of taxes are these..? 1. Toll Road Tax ($1 per day) 2. State income tax where richer citizens pay higher % 3. $.45 tax on cigarettes 4. Medicare tax of 1% of every dollar earned 5.8.25% California sales tax
1. Regressive Tax 2. Progressive Tax 3. Regressive Tax 4. Proportional Tax 5.Regessive Tax
(6.03) What are 2 situations in which a monopoly market situation must be best?
1. a firm has a patent to sell its good or service 2. a firm serves its market as a natural monopoly
Identify which of the following are TRUE public goods (have non-exclusive and non-rival consumption):6.01 1. Hamburgers 2. Satellite TV 3. Free Public Education 4. Homes 5. Street Lights 6. Highways
1. not a true public good 2. might be non rival but you can exclude people who don't pay 3. yes 4. not a public good 5. yes its a public good 6. yes; public good
(6.04) What does each group in the Lorenz Curve represent?
20% of the population
Economists also have something called the free rider problem when talking about public goods. 6.01
A "free rider" is someone who benefits or gets utility from a good or service but does not have to pay for it.
(6.03) In the US, how does regulation often occur as?
Antitrust Laws
(6.04) What is wrong with using averages when it comes to the distribution of income?
Averages reveal nothing about how income is distributed, median is a better way to measure the distribution of income.
6.02 Why dosn't the free market address the problem of externalities?
Because it only expresses the benefits of the consumers who demand the good or service and the costs of the firms who produce the good or service.
What is Nonexclusion?6.01
Cannot exclude people from enjoying the benefits (even if they don't pay directly for the good/service) ex: national defense
(6.03) In 1914 what AntiTrust Act outlawed mergers and acquisition, price discrimination, and tied sales?
Clayton AntiTrust Act
(6.04) All income-earning households are divided into how many parts called what?
Divided into five equal groups called quintiles from the lowest-income groups to the highest. Each quintile represents 20% of the population in the nation or economy.
(6.04) What do economists compare for the Lorenz curve?
Economists compare how the "actual distribution" of income is from perfectly even distribution.
(6.03) In the twenty-first century, the FTC and the U.S Department of Justice continue to do what?
Enforce Antitrust Laws
When should the government get involved in the economy? 6.01
Every society needs to decide how much government involvement is desirable
(6.03) What was created in 1914 to define more specifically what competition was unfair?
Federal Trade Commission
(6.04) What is another name for Proportional Taxes?
Flat tax
Whats wrong with Free Riders?6.01
Free-Riders keep firms from making profits. If left to the free market, essential services would be under produced.
(6.04) Where is there a new gap now in the wages?
Gap between rich and "super" rich
(6.04) What does the government compare in the Lorenz Curve?
How far the actual distribution is from perfect distribution then attempts to redistribute money fairly.
What are some examples of the Invisible Hand of the free market? 6.01
If society wants computers and people are willing to pay high prices then... -businesses have the INCENTIVE to start making computers to earn PROFIT -this leads to more competition -which means lower prices, better quality, and more product variety -to maintain profits, firms find most efficient ways to produce goods and services -the government doesn't need to get involved since the needs of society are automatically met.
(6.03) What if one large firm engaged in practices that were best for its own interests but limited competition and innovation? What is this called?
Invisible Hand Theory of Adam Smith without providing the benefits to all parties in the economy.
(6.03) A conglomerate merger...
Is a merger between firms that are involved in totally unrelated business activities.
Public goods- why must the government provide public goods and services?6.01
It is impractical for the free market to provide these goods because there is little opportunity to earn profit. -this is due to the free rider problem -free riders are individuals that benefit without paying
What does Non-Rival Shared Consumption? 6.01
It means that one person or households consumption of the good or service does not reduce its benefit or utility to others.
(6.03) What came into act when the government sought to limit the power of these trusts?
It passed the ShermanAntiTrust Act in 1890-the nations first AntiTrust Law
What would the supply curve be derived from? 6.01
It would be based on the marginal social cost in much the same way firms supply goods and services to the market based on the costs of production they face.
(6.03) If another firm tried to serve the same market, what would need to happen?
It would need to re-create that infrastructure; and then the two firms would share the market demand. However the price of the good would be so low (below the ATC curve), that one of the firms would have to shut down-leaving only one firm left in the market (NATURAL MONOPOLY)
(6.04) Which of the following is most likely to reduce inequality in a country's distribution of income?
Job training for low skill workers
(6.03) In many cases how were these large firms organized as?
Legal form of a "trust", a group of formerly independent firms were consolidated by mergers and purchases, group of "trustees" then ran the companies as if they were a single firm
6.02 Market demand is based on...
Marginal Social Benefit
What data do we consider when summarizing graphs? (public goods) 6.01
Marginal Social Benefit (additional benefit society gets) and the Marginal Social Cost (the additional cost to society)
In terms of a graph, what would the demand curve be derived from? 6.01
Marginal Social Benefit because society is willing to pay based on the benefit received.
6.02 Market supply is based on...
Marginal private costs of production faced by the firm, this results in overproduction of the good because of the external costs.
(6.04) The Lorenz Curve- government transfer payments shift the Lorenz Curve toward more equality. Is that good or bad?
No correct answer; political question
Consider a simple good like a candy bar purchased in a store. Does it meet the criteria for public goods? 6.01
No! A consumer must buy the good to be able to consume it (people who do not pay are excluded). Also, consumption is rival: one consumer eating the candy bar does exclude someone else from doing so. Because this is the case, it is easy for firms to market and sell candy bars by letting forces of supply and demand determine prices.
What are the two types of criteria that public goods generally meet? 6.01
Non-exclusive and non-rival shared consumption.
What are the two criteria for public goods?6.01
Nonexclusion and Shared Consumption (nonrivalry)
(6.03) As a short term reward, what would the government usually offer?
Often award the patent as a way to protect that firm's investment (the patent legally allows ONLY that firm to sell the good or service that it has developed)
What is a shared consumtion?6.01
One persons consumption of a good does not reduce the usefulness to others ex: city park
(6.04) What are the three most common types of taxes?
Progressive, Proportional, Regressive
What are the two sectors of public goods?6.01
Public Sector, Private Sector Public Sector- the part of the economy that is primarily controlled by the government Private Sector- the part of the economy that is run by private individuals and companies that seek profit
What are public goods? 6.01
Public goods is one example of a market failure. They are often provided free of direct charge for individual citizens but paid for through revenue the government raises through taxes.
What are the Four Market Failures?6.01
Public goods, Externalities, Monopolies, and Unfair distribution of income -in each of the above situations, the government steps in to allocate resources more efficiently
Who is Adam Smith? 6.01
Scottish Enlightenment thinker and discovered the invisible hand theory.
(6.03) Where does this quote originate from? "Every person who shall monopolize...or conspire to monopolize...shall be deemed guilty of a felony."
Sherman Act of 1890
6.02 What would happen without government regulation?
Some markets would overproduce some good(those that cause negative externalities) and underproduce others (those that cause positive externalities)
6.02 What are negative externalities also referred to as
Spillover Costs
6.02 What are positive externalities also referred to as?
Spillover benefits
6.02 How do economists discuss the concept of externalities?
Spillover benefits and costs
(6.03) Why don't taxes work?
Taxes limit supply and thats the problem
(6.03) In a natural monopoly why is it better to have only one firm? (terms of graph)
The ATC is falling at socially optimal quantity
(6.03) In 1950, what extended the Clayton Act by restricting vertical and conglomerate mergers?
The Celler-Kafauver Act
Demand for Public goods-6.01
The Marginal Social Benefit of the good is its usefulness to society and is determined by citizens willingness to pay.
Supply of Public Goods-6.01
The Marginal Social Cost of providing each additional quantity.
(6.04) What happens the farther you go away from the Lorenz Curve?
The farther the Lorenz curve is from the line of equality, the closer the Gini Coefficient will be to one.
(6.03) Regarding a Natural Monopoly, what happens if the government sets a price ceiling to get the socially optimal quantity?
The firm would make a loss and would require a subsidy, if they don't get the subsidy they have no choice but to shut down.
6.02 Why are externalities market failures?
The free market fails to include external costs or external beliefs
6.02 Why are externalities market failures?
The free market fails to include external costs or external benefits. -With no government involvement there would be too much of some goods and too little of others.
What's the result of a market failure?6.01
The government must step in to satisfy society's wants.
(6.04) What is a regressive tax?
These taxes take a larger percentage of income from lower income groups. An example of a regressive tax would be state sales tax. Assume Sally earns $50,000 per year while Hally earns $40,000 per year. They each buy $100 of groceries and pay $7 in taxes (added to the grocery bill). For Hally, the $7 represents a larger percentage of her overall income than for Sally.
(6.03) How can pure monopoly markets be seen as a market failure?
They do not include competitive behavior and because they do not provide efficiency (neither economic/productive nor allocative). Government regulation, though, can help address these issues.
How does the government determine what quantity of public goods to produce?6.01
They use supply and demand
What is the governments main job?6.01
To enforce contracts, secure property rights, and defend the country.
(6.03) Why would the government regulate a monopoly?
To keep prices low, to make monopolies efficient
(6.03) What two options does the government generally choose from when regulating a monopoly?
To set the marginal price=marginal cost(to ensure allocative efficiency) OR to set the monopolies price=the firms average total cost (to ensure "normal" or break-even profit for the firm)
(6.04) What is the fourth market failure?
Unfair distribution of wealth and income
(6.03) What are Antitrust laws designed to prevent?
Unfair monopoly markets and to promote greater competition. Probably the most well-known of these is the US Sherman Act (and other similar laws/regulations that followed)
(6.03) How do the government regulate a monopoly?
Use price controls; price ceilings
(6.03) When would the government grant a patent?
When a firm can demonstrate that the product it is selling is unique or offers something new and of great value to the economy.
6.02 How do externalities occour?
When either benefits or costs are experienced by people other than those involved in an economic transaction or decision
(6.03) How can natural monopolies exist?
When one firm can serve a market best.
What is the invisible hand theory? 6.01
When self-directed gain leads to social and economic benefits for the whole community. Their combined interests that they do our of their own best interests act as an "invisible hand" that will automatically do what is best for the society/economy.
(6.03) A vertical merger ....
When two or more firms, operating at different levels within an industry's supply chain, merge operations.
Where does the optimal quantity of a public good occur?6.01
Where the marginal social benefit equals marginal social cost
(6.03) How can the government best regulate to help ensure a better outcome?
With natural monopolies, the government generally sets a price ceiling -note that in this case a surplus will NOT occur, this is because the monopoly market is the overall market!
6.02 What is determined to be the optimal level for society?
With respect to marginal social benefit and marginal social cost.
What is an example of a free rider problem?6.01
With services like fire and police protection it is difficult to exclude those who would not be willing to pay for the service. Even if we did so, we would probably end up with much smaller police forces and fire departments and communities would suffer. This is another strong argument in favor of government intervention in these types of situations.
Now consider something like your local fire department - or "fire protection services" in economic terms. Does it meet the criteria for public goods? 6.01
Yes! Even consumers who do not pay directly (out-of-pocket) benefit from those services. Although one might argue that a fire department putting out one fire cannot put out another at the same time, generally speaking one consumer or household using/needing the service does not mean it cannot be used by another consumer or household.
6.01 All free-market economies have several basic elements in common, what are these 4 things?
a. Private individuals own all productive resources and get to make economic decisions about them b. The opportunity to make profit (by taking risks) gives people the incentive to produce goods and services for others to purchase c. Competition and the self-interest of individuals and firms work together for the good of the entire system d. Generally, little government intervention is needed in economic matters. This is sometimes referred to by the French term "laissez-faire" (literally "let do" - or "leave it alone" - let the system function properly "on its own").
6.02 Where is the Marginal Social Cost curve located?
above the existing supply curve
(6.03) After the civil war, what led to national markets?
advances in technologies and transportation
(6.04) Although taxes generally serve the same purpose, how can they be categorized?
based on the percentage of income they take from the people on whom the tax burden falls.
(6.03)What does break even profit mean?
basically means that this firm is earning profit that is equal to its average total costs (including opportunity costs); firms can still earn millions of dollars in profit (accounting profit) while operating at the break-even point (price=ATC)
6.02 What would the imposition of a per-unit tax remedy?
deadweight loss
(6.03) In a natural monopoly, one firm can produce the socially optimal quantity at the lowest cost due to_____?
economies of scale
(6.03) "In the closing decade of the 1800s, many industries in the U.S economy were dominated by a single firm that had most of the sales for the entire country. Supporters of these large firms argued that they could take advantage of ____________ and careful planning to provide consumers with products at _____ prices. However, critics pointed out that when competition was reduced, these firms were free to charge _____, and make permanently ______ profits, and that without the goading of competition, it was not clear that they were as ________ or innovative as they could be.
economies of scale low more higher efficient
(6.04) How does the government divide all the income earning families?
five equal groups called quintiles from poorest to richest.
(6.04) What is the Lorenz Curve used to measure?
income distribution
(6.04) Lorenz Curve- If we are further away from the line of perfect equality...
it means more inequality
(6.03) What are Antitrust Laws?
laws designed to prevent monopolies and promote competition
(6.04) In simple terms, what does tax mean?
mandatory payment made to a government to cover the costs "of government".
(6.03)Why are Monopolies a Market Failure?
monopolies destroy a key ingredient of the free market system-competition -to fix this market failure the government must get involved
Practice Question-- a pure public good is a good that is...6.01
nonrivalrous and nonexcludable in consumption
What does Non-Exclusive mean? 6.01
people who do not pay directly for the good or service cannot be excluded from enjoying the benefits of it.
6.02 Why does the negative externality have two COST curves
private and social
6.02 Why does the positive externality have two BENEFIT curves
private and social
6.02 What is a positive externalitie?
situation that results in a BENEFIT for someone other than the original decision maker, the benefits "spillover" to other people or society (LOOK FOR NOTES)
6.02 Situations that cause additional utility for people not involved in the economic transaction or decision are those that have...
spillover benefits; positive externalitie; without regulation they result in underproduction.
(6.04)What would perfect income equality mean?
that 20% of the household would earn exactly 20% of the income; 40% would earn 40% of the income and so on and so forth up to both 100% of the households and income.
(6.04) What does it mean when you are closer to the Lorenz Curve (line of actual income distribution)?
the closer that line is to the line of equality the closer the Gini Coefficient calculation will be to zero.
(6.04) The closer the Gini coefficient is to 0..
the closer we are to perfect distributable income
Which of the following is not a characteristic of free-market capitalism?6.01
the government usually owns most of the productive resources
The closer the Gini coefficient gets to 1...
the worse we are at having our income perfectly distributed
(6.04) Lorenz Curve- If we are close to the line of perfect equality...
then that means better distributed income
(6.04) Why does the government generally enact taces?
to finance their operations, but they can also enact taxes to influence behavior of individuals and firms
(6.04) What do economists use the Gini Coefficient for?
to quantify income distribution in an economy.
Does the Free Market ever FAIL to meet society's needs?6.01
yes