Market Analysis and Efficiency

Club Good

- a good that is now excludable, but non rival in consumption - used to be a public good that was unprofitable, but now is a profited industry by businesses (ie. cable television instead of antennas, movie theaters)

Externality

- a side effect on bystanders whose interests are not taken into account (can be positive or negative) - a price change is not an example

Free-Rider Problem

- occurs when someone benefits from something without bearing the costs of it - markets underproduce public goods

Nonrival Goods

- products whose enjoyment by one individual doesn't remove from the enjoyment of others - free-riders enjoy positive externalities from these (ie. breathing clean air, seeing beautiful architecture

Marginal Social Benefit

- the sum of marginal benefit accruing to the buyer (the demand curve) and the marginal external benefit that accrues to the bystander (above demand curve if positive, below if negative) - = marginal private benefit + marginal social benefit

Marginal Social Cost

- the sum of marginal private costs paid by the seller (the supply curve) and marginal external costs borne by the bystander (above supply curve if negative, below if positive) - = marginal private cost + marginal social cost

5 main sources of market failure

1) Market power undermines competitive pressures 2) Externalities create side effects 3) Information problems undermine trust 4) Irrationality leads to bad decisions 5) Government can impede market forces

3 Critiques of Economic Efficiency

1) distribution matters, but it is also important to account for equity 2) willingness to pay reflects ability to pay, not just marginal benefit 3) the means matter, not just ends (process matters as much as outcome)

3 Step Process

1. determine time taken for each buyer 2. determine opportunity costs for each buyer against other options 3. determine comparative advantage for each buyer against another buyer

Equity

Concerns whether a policy will yield a fair distribution of economic benefits

Consumer surplus equation

Consumer surplus = (marginal benefit - price)

Deadweight loss equation

Deadweight loss = (economic surplus @ efficient quantity - actual level of economic surplus)

Normative analysis

Describes what should happen based on opinions

Positive analysis

Describes what will happen based on facts

Economic surplus equation

Economic surplus = (consumer surplus + producer surplus) or = (marginal benefit - marginal cost)

Voluntary exchange

Ensures both buyers and sellers enjoy gains from trade

Efficient production

Occurs when a given level of output is produced at the lowest possible cost

Efficient allocation

Occurs when goods are allocated to create the largest economic surplus, going to the person with the highest marginal benefit

Market failure

Occurs when the forces of supply and demand lead to an inefficient outcome

Producer surplus equation

Producer surplus = (price - marginal cost)

Economic surplus

The area between the demand and supply curves where both curves hit the equilibrium price

Deadweight loss

The difference between the largest possible economic surplus and the actual level of economic surplus (deadweight loss is more important from changing quantities, not prices)

Consumer surplus

The economic surplus gained from buying something, represented by the area beneath the demand curve and above the price

Producer surplus

The economic surplus gained from selling something, represented by the area above the supply curve and beneath the price

Efficient quantity

The quantity that produces the highest possible economic surplus

Rational rule for markets

To increase economic surplus, only increase production if marginal benefit is equal to or greater than marginal cost

Efficient outcome

Yields the largest possible economic surplus

Diminishing Marginal Benefit of Income

as income rises, total benefit rises, but at a diminishing rate so as you become richer/wealthier, each dollar means less than a dollar for a poorer person

Common Resources

goods that are rival but nonexcludable (ex. fishing in a ocean, but once you catch the fish, you benefit from eating it, but other people take the cost of less fish in the ocean)

Socially Optimal Quantity

marginal social benefit = marginal social cost

Equality of Opportunity

policy that seeks to improve education so people can build their skills and talents; everyone is given an equal chance of success

Equality of Outcome

policy that seeks to redistribute income fairly amongst everyone

Rational Rule for Society

produce more of a good if its marginal social benefit is greater than (or equal to) the marginal social cost.

Nonexcludable Goods

products which cannot easily be excluded from other people

Corrective Tax

tax which induces people to take account of the negative externalities they create (usually set to equal the marginal external cost)

Comparative Advantage

the ability to produce a good at a lower opportunity cost

Absolute Advantage

the ability to produce a good using fewer inputs

Coase Theorem

the proposition that if private parties can bargain costlessly (so that it's easy to strike a deal), and legal rights are clear and enforced (so both parties uphold their sides of the deal), then externality problems can be solved by private bargaining

Tragedy of the Commons

the tendency to overconsume a common resource can be solved by: assigning ownership rights

The Knowledge Problem

when knowledge needed to make a good decision is not available to the decision-maker

Intergenerational Mobility

when the social/wealth of the child is higher than their parents