Economics Chapt. 5

Externalities

external costs or external benefits that fall on bystanders.

Does it matter who bears the Externality cost?

for determining efficient quantities, who bears the costs is irrelevant—costs are costs regardless of who bears them.

production possibilities frontier

hows all the combinations of goods that a country can produce given its productivity and supply of inputs.

Thinking on the margin

making choices by thinking in terms of marginal benefits and marginal costs, the benefits and costs of a little bit more (or a little bit less).

Total consumer surplus

measured by the area beneath the demand curve and above the price.

elasticity of demand

measures how responsive the quantity demanded is to a change in price; more responsive equals more elastic.

Comparative advantage

producing goods for which it has the lowest opportunity cost.

What does a tax on a good with external cost do?

tax on a good with an external cost reduces deadweight loss and raises revenue.

absolute advantage

the ability to produce the same good using fewer inputs than another producer.

social cost

the cost to everyone: the private cost plus the external cost.

efficient equilibrium

the price and quantity that maximizes social surplus.

equilibrium

the price at which the quantity demanded is equal to the quantity supplied.

equilibrium quantity

the quantity at which the quantity demanded is equal to the quantity supplied.

External Costs vs Benefits

(External costs are sometimes also called negative externalities, and external benefits are some- times also called positive externalities.

Supply Shifters

> Technological innovations and changes in the price of inputs > Taxes and subsidies > Expectations > Entry or exit of producers > Changes in opportunity costs

Demand Shifters

>Income > Population > Price of substitutes > Price of complements > Expectations > Tastes

why does a a free market maximize producer and consumer surplus?

A free market maximizes the gains from trade. The gains from trade can be broken down into producer su-plus and consumer surplus, so we can also say that a free market maximizes producer plus consumer surplus.

Pigouvian tax

Arthur C. Pigou (1877-1959) who first focused attention on exter- nalities and how they might be corrected with taxes.

How does the Pigu tax help with signals

If there are external costs, the market price is too low, thus resulting in overconsumption. A Pigouvian tax increases the price so that the after-tax price sends the correct signal. Similarly, if there are external benefits, the market price is too high, thus resulting in underconsumption. A Pigouvian subsidy reduces the price so that the after-subsidy price sends the correct signal.

Elasticity rule

If two linear demand (or supply) curves run through a common point, then at any given quantity the curve that is flatter is more elastic.

external benefit

a benefit received by people other than the consumers or producers trading in the market.

substitutes

a decrease in the price of one good leads to a decrease in demand for the other good.

demand curve

a function that shows the quantity demanded at different prices

supply curve

a function that shows the quantity supplied at different prices.

inferior good

a good for which demand decreases when income increases.

normal good

a good for which demand increases when income increases.

shortage

a situation in which the quantity demanded is greater than the quantity supplied

surplus

a situation in which the quantity supplied is greater than the quantity demanded.

Pigouvian subsidy

a subsidy on a good with external benefits.

Transaction costs

all the costs necessary to reach an agreement.

quantity supplied

amount of a good that sellers are willing and able to sell at a particular price.

Incentives

are rewards and penalties that motivate behavior.

Social surplus

consumer sur- plus plus producer surplus plus everyone else's surplus.

Consumer surplus

consumer's gain from exchange, or the difference between the maximum price a consumer is willing to pay for a certain quantity and the market price

external cost

cost paid by people other than the con- sumer or the producer trading in the market.

private cost

cost paid by the consumer or the producer.

complements

decrease in the price of one good leads to an increase in the demand for the other good.

Coase theorem

The Coase theorem says that if transaction costs are low and property rights are clearly defined, then private bargains will en- sure that the market equilibrium is efficient even when there are externalities. In other words, in these cases trading makes sure that just the right amount of the externality is produced. If there were either too little or too much of the externality, trading would push the quantity to the optimum level.

What curve does the social value curve intersect

The social value curve counts all the benefits of vac- cine use, the private value plus the external benefits, so the efficient quantity is found where the social value curve intersects the supply curve. So, demand curve