Chapter 10 and 19- microeconomics

payoff

benefit or cost associated with a particular action

Pigovian taxes and subsidies

government taxes and subsidies intended to bring about an efficient level of output in the presence of externalities

Elinor Ostrom

her framework for institutional design consists of the following: - limit access - assign accountability - graduated sanctions

types of goods

- normal or inferiors - luxury or necessity

Asymmetric information:

- one party has more/better information than the other - EX: Patients and insurance companies, professors and students, used car sellers and buyers

signals to overcome as asymmetric information:

- signaling: expenditures of time, money, or other resources by one person (agent) to try to convince others (the principal) of something - EX: car companies offering extended warranties, wearing a Rolex to indicate wealth, criminals tattooing their faces, diamond engagement rings

moral hazard and the principal agent problem:

- two parties: principal (owner), agent (manager of good) - this problem arises when ownership of a good is separated from control of the good - ideally, the agent acts on behalf of the principal. But this may not always occur if the incentives of the principal and agent are not aligned

Solutions of moral hazard

1. make information more symmetric 2. reduce the incentive of the agent to exploit their information advantage

Characteristics of goods:

(1) Excludable/non-excludable? (2) Rival in consumption/non-rival in consumption? Excludability: resource can be limited to paying customers only

Tragedy of the commons:

- A common pool resource is an economic good that is rivalrous but non-excludable - Example: many (not all) lakes, rivers, ocean fisheries, public forests, reservoirs, aquifers, and other sources of water, the atmosphere

Tradable permits

- A government-issued permit that allows a firm to emit a certain amount of pollution during production and that can be traded to other firms - Trying to target the price can be difficult (due to reasons mentioned) so some advocate issue tradable permits to control pollution

Pigouvian subsidies

- A subsidy that equals the external benefit imposed by an externality - Subsidize production and consumption

Problems with the Pigouvian idea:

- How do we enforce these rules? - How do we know what the optimal tax or subsidy would look like? - How do we calculate.... - The cost of someone's distaste for smoke? Or intensity of preference? - Taxes may kill off firms who produce highly valuable products

Pigouvian taxes (named after A.C. Pigou)

- Idea: tax goods associated with negative externalities - Goal: improve societal welfare ny causing the buyer and seller to internalize the full cost of their actions

Policy Analysis - Saving Endangered Species Zimbabwe and Kenya's elephant population

- Kenya government banned all hunting in 1977, after this policy poaching went up and the elephant population decreased tremendously - Contrast to this policy, Zimbabwe advocated a different approach which was private property rights. This increased the elephant population and even increased employment! - What we can learn from this, property rights are awesome. They allow us to internalize externalities

The Coase theorem:

- Markets fixing externalities on their own - Under certain circumstances, it may be possible to reach the efficient market outcome through private investigation - Costless negotiation (zero transaction cost) + Private property rights - It doesn't matter who has a property right = If outcomes can be monitored and individuals can costlessly coordinate and negotiate, parties should be able to reach the efficient outcome

What happens with public goods?

- Supply side issue: Disincentive to produce because sellers cannot capitalize on the good - Consumer side issue: Incentive to "free ride" consumer the good without paying

Is Higher education a signal?

- if college is all about learning skills we'd expect to see a steady increase in income based on amount of college completed - however we don't, instead we see a big increase at the end (sheepskin effect) - education may serve as a signal to employers (how hard working, smart, or conscientious is an employee?)

moral hazard: - scenario: you go to get your oil changed

- information is asymmetric - the mechanic may have an incentive to use their information advantage to exploit the other party

Classify the scenarios according to whether or not they describe a negative externality.

An example of a negative externality: -A factory emits pollution into the atmosphere as a by-product of production. -A neighbor plays loud music that annoys the surrounding community. Not an example of a negative externality: -A person gets a flu shot and is therefore less likely to spread illness to others. -A person with no allergies gets a mosquito bite from a disease-free mosquito. -A donut shop emits a delicious smell into the air as a by-product of production.

Merryweather's courthouse square is well‑known for its elaborate decorations, including a real Santa for the children. Unlike at the mall, parents are not required to buy a photo before their children can talk to Santa, but the line is long and Santa leaves at 8:00 p.m. santa is _____

Common resources common resources are rival but not excludable. Santa is rival since he can only listen to one child at a time, but no one is being excluded since no payment is required. Santa is therefore a common resource. A classic example of a common resource is the fish in the oceans.

The terms "social cost" and "external cost" are synonyms.

False

- Suppose that two companies are considering reducing their carbon output, maybe due to threat of globalization - They each face the same choice: Cooperate (reduce pollution) or Don't cooperate (continue polluting) - what will happen?

Ideally both companies would cooperate, but because they would be better off by letting the other company "clean up" for them, they can keep their current benefits without sacrifice

Why do people keep polluting?

People know that society would be better off if everyone were more environmentally friendly, yet people and companies continue to pollute

Bob's Hardware Store stocks a large selection of the most commonly used lights for sale. Bob's lights are _____

Private goods private goods are both rival and excludable. Because only one person can buy any particular string of lights and because only those who pay for them are allowed to take them home, the lights at Bob's Hardware are private goods. Most goods and services are private goods.

the smaller the group ____

The smaller the group, the easier it is to monitor, everything else equal. In small villages or groups, it is easier for the leadership to identify the individual overusing a common resource and make that person accountable. For example, if two people live on a country road, both know whose garbage is strewn along the side of the road. In a city, only one person knows who threw the gum wrapper on the sidewalk. It will be easier for one neighbor to put pressure on the transgressor to dispose of the garbage properly than for citizens in the city to eliminate litter.

Which scenario is the best example of the tragedy of the commons?

The tragedy of the commons is the idea that people overuse or misuse common resources, or resources that are non-excludable but rival in consumption. The best example of this here is the residents of a dorm that do not clean their common shower. The common good is a shower that is overused in the sense that the shower is not as clean as it would be if the shower were privately owned. This is because if any resident cleans the shower they alone bear the cost but every resident enjoys the benefits. It is possible to overcome the tragedy of the commons. For example, the dorm residents could all agree to take turns cleaning the shower, or the university could charge students a fee to spend on dorm-cleaning services.

an externality requires at least three actors

a buyer a seller a third party

externalities

a cost or benefit that affects a third party not directly involved in transaction

Positive externalities, not enough of

a good thing

Prisoner's Dilemma

a particular "game" between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial

Negative externalities occur when

a transaction generates an external cost Ex: secondhand smoke, Cheating, overuse of antibiotics, listening to things without headphones

efficient markets take

all costs and benefits both private and social into account

Markets are efficient when

all transactions that positively benefit society take place

positive externalities exists when

an activity generates benefits to individuals outside of the transaction Ex: school, radio, flu shot

Maple Havens, an expensive gated community, has tasteful light displays sponsored by the neighborhood association. Only those who know the code to unlock the gates are able to drive through the streets and enjoy the lights. Maple Havens lights are ______

club goods Club goods are not rival but are excludable. Maple Havens's lights are a club good because, unlike downtown, the gate at the entrance prevents just anyone from driving through the neighborhood. Because of this limitation on cars, one person's enjoyment of the lights does not keep anyone else in the neighborhood from enjoying them as well.

Nonrivalrous Excludable:

club goods (movie theaters, private parks and pools, streaming)

Rivalrous Non-excludable:

common-pool goods (fish stocks, coal or miners)

private goods

excludable most goods (computers clothes, haircuts)

pay per view

excludable nonrivalrous Pay-Per-View television can be blocked from nonsubscribers by scrambling it. Pay-Per-View television shows can be very cheaply descrambled to anyone who wants to pay for that channel without affecting the ability of others to view it.

Amos is a pacifist, meaning he is opposed to all war and violence. He is required to pay a portion of his income as tax toward an annual national defense budget, which includes spending on war, war machines, and warfare training. category

forced rider Amos, as a pacifist, would be opposed to any spending at all on military projects. However, revenue from his taxes is still used to help fund this operation.

Linus is required to pay a 2% tax from his salary for a new city‑wide beautification project. However, Linus hasn't worked in many years because he is retired, yet still enjoys taking his time walking through the city's new parks and gardens. category

free rider Linus is required to pay a 2% tax from his salary for a new city‑wide beautification project. However, Linus hasn't worked in many years because he is retired, yet still enjoys taking his time walking through the city's new parks and gardens.

excludable rivalrous examples

hot pocket, private classroom education, pajamas, a unicycle An excludable item is one that actors can prevent other actors from using. It is a very useful property for items that you wish to sell, as you can then separate the payers from the non-payers. Rivalrous items are those in which consumption by one actor decreases the enjoyment of the good by others. As more people use a clean water source, less water is available. A unicycle seats only one person. As one person eats a Hot Pocket, there is one less Hot Pocket available for others to eat. Only one person can wear a pair of pajamas at a time. There is a limited amount of space in a classroom before it gets crowded (although online classes are a different situation).

economic inefficiencies from externalities

in the presence of externalities, society's benefit or cost from a transaction is different from the private benefit or cost

rivalrous good

its use by one individual makes it less available for use by others

national defense is

non-excludable and nonrivoulrous Non-excludable goods are those that are essentially impossible to block other actors from consuming under normal, realistic situations. As long as a person lives within a country, they can enjoy the protection the military provides. A nonrivalrous good is a good in which one person's consumption does not stop another person from consuming it. For example, all citizens of a country will equally benefit from national defense, regardless of how many citizens there are.

playing World of Warcraft, a massive multiplayer online computer game

nonrivalrous and excludable

street lighting in a public park:

nonrivalrous and nonexcludable

Emily loves to watch television and is thankful that her local city council provides everyone in the city with a TV set and 60 channels, even though she is required to pay an extra yearly fee. category

paying their part Emily loves to watch television and is thankful that her local city council provides everyone in the city with a TV set and 60 channels, even though she is required to pay an extra yearly fee.

externalities may be

positive or negative

Rivalrous Excludable:

private goods: most goods (computers clothes, haircuts)

As part of the holiday celebration, the local church bells play carols every evening. the church bells are _____

public goods Public goods are neither rival nor excludable. Once the bells are played for one listener, they are played for everyone in town and no one can be prevented from hearing them; therefore, the church bells are public goods. National defense is a classic example of a public good, but being provided by the government is not part of the definition of a public good. Most public goods are provided by the government but only because there is little or no incentive for anyone else to do so.

Nonrivalrous Non-excludable:

public goods (air, tornado sirens)

a chipotle burrito

rivalrous and excludable

wild tuna in the Pacific Ocean for which no fishing permit is required:

rivalrous and non-excludable

there is a difference between the market price and the efficient price of the good

the market output (Qmarket) is different from the efficient output (Qeff)

excludability good

the situation in which anyone who does not pay for a good cannot consume it