Microeconomics

Define price ceiling and discuss

- A price ceilin (a maximum price) occurs when the government sets a price below the market equilibrium price to encourage consumption. Eg. rental rates. - Resulsts in excess demand: causing non-price rationing mechanisms: queing, ration coupons and most-favored customers - Cause underground markets to occur due to shortages.

When do externalities arise?

- An externality occurs when the prduction or consumption of a good or service has an effect upon a third party, that is not reflected in the price. - If the effect is harmful, it is a negative externality, and an external cost must be added to the privat costs to reflect the true cost to society - If the effect is beneficial, then it is a positive externality and an external benefit is added to the privat benefits of the consumer.

Dicuss solutions to negative externalities of consumption

- Ban (but illegal markets, unemployment in that industry, represents loss of revenue for gov. ) - Indirect tax to shift MSC upwards to MSC+tax. This will recude consumption to the socially efficeinty output, but consumers face a higher price. >> Gov. gains revenue. BUT inelastic demand means taxes do not manage to reduce quantity demanded very much. - Gov. could provide edu about the dangers of smoking and also fund neg. advertising in order to reduce demand, thus shifting MPB to the left, towards MSB>> Opportunity cost. May not be effective, consumers may not respond.

Evaluate subsidies

- COnsumers benefit from lower prices - Producers benefit from lower COPs: higher output and profitability, improves competitiveness. - However may lead to inefficiency. - Represents opportunity cost for government.

Discuss fully the over-supply of demerit goods

- Demerit goods are ones that have negative spill over effects when produced or consumed (negative externality) and are therefore seen to be over-consumed from sociesties stand-point. - They are goods the government thinks are bad for people who consume them and for society as a whole, thus they would like to reduce consumption. 1) Governments intervene according to how damamging they think they are. Child pornography and drugs are completley banned (but this gives rise to the illegal market) - Less harmful demerit goods will instead be taxed. More harmful ones may be taxed more heavily than none harmful ones.

Give examples of prices floors.

- Farmers are guranteed a minimum price - Minimum wage. But leads to unemployment. - Dead weigth loss.

When does social efficiency occur?

- If no externalities exist in a market, then MSC=MSB and we have social efficiency and so maimum community surplus . If externalities do exist then MSC does not equal MSB and so there is a market failure and an inefficient allocation of sociaties resources.

Discuss "issuing tradable emission permits" as a gov. strategy to reduce neg. externality of production

- Known as "cap and trade system" - Market based solution to neg. externality of production - Tradable emission permits are issued by the gov. and give firms the licence to create pollution up to a set level - The gov. decides upon the level of pollution that it will permit each year and then splites the toal level of pollution up into a number of tradable emission permits, each allowing a certain level of pollution. The gove. then allocates these permits to individual firms -->> Thus each firm gets a quota of emission that it is allowed to produce. - The market takes over: it is in the interest of the firm to reduce emission output as it will need to buy extra permits or it can sell unused ones. >>> Difficult to set limit and difficult to measure emission output of firms. - In the USA the emission of CFS is controlled by the use of tradable emission permits - Global level (KYOTO PROTOCOL is an attemtp to reduce global emission of greenhouse gases)-

Discuss fully the under-supply of merit goods

- Merit goods are goods that have positive spill over effects (positive externalities when consumer) on both the people consuming/producing them and to society as a whole. - These are underprovided by the free market and will therefore be underconsumed. - Governments try to increase supply and consumption, how they do this is dependent on how important the gov. judges the good to be. - Very importan (health care and education): government will provide them directly or subsidize them to the point where they are availble at no direct cost to the consumer. (cost is shared amoung tax payers) -Less important (sports facilities and opera): government subsidy will be smaller. - OPPORTUNITY COST

Disucss the cause/theory positive externality of production

- Occur when the production of a good or service creates external benefits that are good for third parties. - From societies stand-point production/output level is too low - Occurs when the MPC>MSC. - For example high quality training provided by a firm, represents a cost to the firm. It also represents a benefit to society, as the employees when they leave will have a greater skill set. - The firm produces at output level Q1, that is below the socially efficient level Q*. Between Q1 and Q* there is a potential welfare gain, because for all these units MMSB is greater than MSC.

Disucss the cause/theory negative externality of production

- Occur when the production og a good or service creates an external costs/damages third parties. - Mainly environmental problems. - MSC is greater than the MPC of the firm (MSC=MPC+external costs) - The firm will only be concerned with its private costs and produce at Q1. It is not producing at the socially efficient output, Q* where MSC=MSB. - Too much paint is produced from societies point of view (Q*-Q1) = there is a misallocation of sociesties resources; too much paint is being produced at too low a cost. - The is a welfare loss to society of the extra units from Q1 to Q*, because the MSC is greater than the MPC for those units (shaded traingle) - In a free market this continues because firms only take into account their private costs of production.

Discuss fully the lack of public goods

- Public goods are merit goods that have the two characteristics of being non-excludable (other people will gain benefit although they havnt paid, the free rider problem) and non-excludable (one person consuming the product does not prevent others from consuming it aswell). >> These characteristics mean that public goods will be undersupplied in a free-market. 1.) Governments intervene: - Direct provision of the merit good. This is the case with national defense, street lighting, flood barriers. Tax payers pay, spreading the money over a large number of people. - Subsidise privat firms, covering all costs, to provide the good.

Disucc solution to positive externalities of conumption

- Subsidize: shift MSC curve downwards and in this way the socially efficient level of consumption at Q1 could be reached, with a price of P2. May subsidize it to the point where it is free to the consumer >> opportunity cost. Developing countries are not able to fund such schemes and so do not fully benefit from the benefits of healthcare and edu. - Gov. could use positive advertising to encourage peope to consume more. This would shift MPB towards MSB, increasing welfare.>> Costs, may only have long-term effects. - Could enforce laws about vaccination and minimum schooling.

Discuss monopolies as neg. externalities

- The lack fo competition means that profit-maximising monopolists are likely to supply less than the social optimum and charge higher prices, ie. there is a productive and allocative inefficiency.This results in welfare loss. Therefore a type of market failure. EXAMPLES INCLUDE: 1) excessivly high prices 2) collusion - agreement between firms to set higher prices 3.) Predatory pricing- setting prices low, perhaps below COPs to force rival firms out of the industry. SOLUTIONS: - Lesislation: illegal for firms to charge too high prices - Regulation: rules that prohibit anti-competitive acts - Nationalisation - gov. takes over industry with the aim of running it in the best interest of the ppl. - Trade liberalisatoin: removing/reducing barriers to exchange of G&Ss between countries to generate greater competition and thus reduce the potential for firm to exploit their monopoly power.

Disucss the cause/theory negative externality of consumtion

- These occur when consumption of a product has adverse effects on a third party - (cigarettes, alcohol, car pollution, noise pollution) - Marginal social benefit>marginal social benefit - In a freemarket consumers will maximise their private utility (benefit) at a level where MPB=MSC. This means they will overconsume cigarettes by smoking Q1 at price P1. The socially efficient ouput is at Q* and so there is over-consumption of Q1 to Q*. Since MSC is greater than MSB for these units, there is a welfare loss to society=market failure.

Disucc positive externalities of conumption

- This occurs when the consumption of a good has a positive effect on third parties. Examples include healthcare and education. - When ppl "consume" these, they create positive externalities (less likely to infect others and a healthier workforce means greater productivity, which in turn benefits the whole population). Thus MSB is greater than MPB. - In a free market Q1 is consumed at a price of P1. However the socially efficient level of consumption would be Q* where MSB=MSC. - There is potential welfare gain of the traingle, because from Q1 to Q* MSB is greater than MSC. Thus if consumption increases welfare in society will too.

Define assymetric information disucss how it can be solved

- exists when a buyer or seller in an economic transaction has more information than the other in a certain market. This results in market inefficienes, where community surplus is not maximised. ->>Provide info for consumers (nutritional info on packaging), regulation (forexample on ads)

What are the purposes of a subsidy

1) Encourage output of merit goods 2) Limit neg. externality such as poluttion by subsituting green technologies 3) Protect certain industries and to prevent a subsequent decline in employment

List the types of market failure

1) Lack of public goods 2.) Undersupply of merit goods 3.) oversupply of demerit goods 4.) Existence of externalities

Discuss the solutons to negative externalities of production

1) Tax firm, to increase MPC and shift it towards the MSC, to reach the point of social efficiency. If the tax is equal to the external cost it is "internalised", if not it only reduces the deadweight burden (still a welfare loss). But it is difficult to calculate the size of the external costs and identify which firms are polluting and tax dont stop pollution from taking place. 2.) Gov. could ban or legislate polluting firms, or restrict their output. 3.) Gov. could pass laws relating to measurable environmental standards in the firms production units. To meet the standards firms would have to spend money, thus increase private costs.>> May cause unemployment and non-consumption of what is being produced. The cost of setting/enforcing the standards may be greater than the cost of the polution. 4.) Gov. could issue tradable emission permits

List the diff. types of market failures

1. Underprovision of merit goods, such as educaton and healthcare, as these services would only be provided to those who were willing nd able to pay. 2. Underprovision of public goods, such as flood barriers and streetlighting, because producers cannot exclue those who do not pay from benefiting from the provision of the service - Over-provision of demerit goods: such as tobacco, alcohol, junk food (as there is a lack of gov. intervention in such markets) - Assymmetric information - Abuse of monopoly power: chargin customers prices above market equilibrium and hence the assosciated ineffciencies.

Dicuss solutions to positive externalities of production

1.) Gov. could subsidize firms that offer training. This shifts MPC downwards by the subsidiy (due to lower costs of production). If a full subsidy is given, then the MPC shifts to the MSC and economy operates at the socially efficient point, where MSC=MSB. >> Difficult to estimate the size of the subsidy + represents an opportunity cost for the firm. 2.)Provide vocational training through the state, by setting up training centres for woker in certain industries. >> Costs may be high, trainers may lack the expertise of firms

Define demerit goods

Are products that create a negative spillover effects (or negative extermalities) to society. Hence their production and consumption result in social costs greater than private costs of production and consumption MSC>MPC. - Examples include cigarettes, alcohol, junk food

Define externalities

Externalities or spillover effects are the external costs or benefits of an economic transaction, causing the market to fail to achieve a social optimum level of output, where marginal social benefits equal marginal social costs (MSC=MSB)

Define subsidy

Financial assistance from the government to encourage output (such as sale of exports), to reduce the price of certain merit goods (such as education, training and healthcare) ot to keep down the cost of living (food prices)

Define MSB

Marginal social benefit is equal to the marginal private benfit plus minus and external benefits or costs of consumption

Define MSC

Marginal social cost is equal to the private cost plus or minus any external cost or benefit of production. If there are no external costs then MSC=MPC

Define common access resources

aka common-pool resources refer to communal or public property. They are rivalrous in nature, but are non-excluable.

Define public goods

are goods and services that exert positive externalities, with two key characteristics: non-rivalrous and non-excludable and so would not be provided in the free market. Examples national defense, street lightin, flood barriers 2) Non-excludable: It is impossible to stop other ppl consuming the good once it has been provided. (Free rider problem), the other ppl will gain from the good even if they have not paid. 1) Non- rivalrous: A person´s consumption of a public good does not limit the benefits availble to other people. (by contrast, the consumption of a privat good reduces the quabitity available for others)

Define merit goods

are products that create prositive externalities (spillover effects) when they are produced or consumed. - Hence social benefits of production and consumption are greater than the private benefits. - Examples: education, healthcare provision, training, research and development expenditure, provision of sports and recreational facilities.

Define normal goods

are products that customers tedn to buy more of as their income level increases. They comprice neccesities (food) and luxuries (cars)

Define inferior goods

are products with a negativ income elasticity of demand. Their demand tends to decrease as consumer income increases. Canned foods, frozen meats and vegtables.

Define luxury goods

are superior goods and services as their demand is highly income elastic. ie. an increase in income leads to a proportionatly greater increase in the demand for luxuries.

Define social costs and social beneftis

are the true (or full) benefits/costs of consumption or production. (sum of private benefits and external benefits) (sum of private costs and external costs)

Define market failure

exists when the price mechanism (forces of supply and demand( allocates scarce resources in an inefficient way, i.e. there is either over-provision or under-provision of certain goods and services.

Define price floor

is the imposition of a price gurantee set above the market price to encourage supply of certain goods. - Ex. agricultural farmers: price floor gives incentive for producers to supply more. - The excess supply is bought at the set price by the gov. to support the farmers, and released onto the market during bad harvest to stabilise food prices. - Dead weigth loss.