microeconomics test 2

welfare economics

●Total Surplus = Consumer Surplus + Producer Surplus (Chp. 7) ●Consumer Surplus is the consumer's willingness to pay ●Producer Surplus is the producer's profit ●Deadweight Loss- The decrease in total surplus due to a market event or distortion

important characteristics of goods

-a good is excludable if a person can be prevented from using it -excludable if a person can be prevented from using it -excludable: fish tacos, wireless internet access -not excludable-=FM radio signals. national defense -a good is a rival in consumption if one persons use of it diminishes others use (rival:fish tacos, not rival: an mp3 file of Kanye wests latest single)

the government can attempt to remedy the problem

-can internalize the externality using corrective taxes, can issue permits to polluters and establish a market where permits can be traded, such policies often protect the environment at a lower cost to society than direct regulation

corrective taxes vs regulations

-different firms have different costs of pollution abatement -efficient outcome: firms with the lowest abatement costs reduce pollution the most -a pollution tax is efficient: firms with low abatement costs will reduce pollution to recuse their tax burden, firms with high abatement costs have greater willingness to pay tax -in contract, a regulation requiring all firms to reduce pollution by a specific amount not efficient

objections to economic analysis of pollution

-no one should be able to but the right to pollute, can't put price on env -however people face tradeoffs, clean air or water must be compared to cost -reduces the cost of environmental protection, so it should increase public demand for a clean env

tradable pollution permits

-reduces pollution at lower cost than rehgulation -firms with low cost of reducing pollution do so and sell their unused permits -firms with high cost of reducing pollution buy permits -result: pollution reduction is concentrated among those firms with lowest costs

why private solutions dont always work

-transaction costs- the costs parties incur in the process of agreeing to and following through on a bargain, these costs may make it impossible to reach a mutually beneficial agreement -stubbornness-even if a beneficial agreement is possible, each party may hold out for a better deal -coordination problems-if number of parties is very large, coordinating them may be costly, difficult or impossible

monopoly does not have an s curve

A competitive firm takes P as given has a supply curve that shows how its Q depends on P. A monopoly firm is a "price-maker," not a "price-taker" Q does not depend on P; Q and P are jointly determined by MC, MR, and the demand curve. Hence, no supply curve for monopoly.

The key difference:

A monopoly firm has market power, the ability to influence the market price of the product it sells. A competitive firm has no market power.

tragedy of the commons

A parable that illustrates why common resources get used more than is socially desirable. Setting: a medieval town where sheep graze on common land. As the population grows, the # of sheep grows. The amount of land is fixed, the grass begins to disappear from overgrazing. The private incentives (using the land for free) outweigh the social incentives (using it carefully). Result: People can no longer raise sheep.

coase theorem

CASE 1: Mark has the right to keep Spot. Benefit to Mark of having Spot = $500 Cost to Jessica of Spot's barking = $800 Socially efficient outcome: Spot goes bye-bye. Private outcome: Jessica pays Mark $600 to get rid of Spot, both Jessica and Mark are better off. Private outcome = efficient outco

coase thereoem

CASE 2: Jessica has the legal right to peace and quiet. Benefit to Mark of having Spot = $800 Cost to Jessica of Spot's barking = $500 Socially efficient outcome: Mark keeps Spot. Private outcome: Mark pays Jessica $600 to put up with Spot's barking. Private outcome = efficient outcome. the private market achieves the efficient outcome regardless of the initial distribution of rights

Common resources are rival in consumption but not excludable. Examples include common grazing land, clean air, and congested roads. People can use common resources without paying, so they tend to overuse them.

Therefore, governments try to limit the use of common resources.

price discrimination

Discrimination: treating people differently based on some characteristic, e.g. race or gender. Price discrimination: selling the same good at different prices to different buyers. The characteristic used in price discrimination is willingness to pay (WTP): A firm can increase profit by charging a higher price to buyers with higher WTP.

internalizing the externality

altering incentives so that people take account of external effects of their actions ex: a one dollar per gallon tax on sellers makes sellers' costs=social costs

public goods

If the benefit of a public good exceeds the cost of providing it, govt should provide the good and pay for it with a tax on people who benefit. Problem: Measuring the benefit is usually difficult. Cost-benefit analysis: a study that compares the costs and benefits of providing a public good Cost-benefit analyses are imprecise, so the efficient provision of public goods is more difficult than that of private goods.

price discrimination in real world

In the real world, perfect price discrimination is not possible: No firm knows every buyer's WTP Buyers do not reveal it to sellers So, firms divide customers into groups based on some observable trait that is likely related to WTP, such as age.

public policy toward monopolies

Increasing competition with antitrust laws Ban some anticompetitive practices, allow government to break up monopolies. e.g., Sherman Antitrust Act (1890), Clayton Act (1914) (e.x. Pepsi merging with Coke) Regulation Government agencies set the monopolist's price. For natural monopolies, MC < ATC at all Q, so marginal cost pricing would result in losses. If so, regulators might subsidize the monopolist or set P = ATC for zero economic profit. Public ownership Example: U.S. Postal Service Problem: Public ownership is usually less efficient since no profit motive to minimize costs Doing nothing The foregoing policies all have drawbacks, so the best policy may be no policy.

profit maximization

Like a competitive firm, a monopolist maximizes profit by producing the quantity where MR = MC. Once the monopolist identifies this quantity, it sets the highest price consumers are willing to pay for that quantity. It finds this price from the D curve.

common resources

Like public goods, common resources are not excludable. Cannot prevent free riders from using Little incentive for firms to provide Role for govt: seeing that they are provided Additional problem with common resources:rival in consumption Each person's use reduces others' ability to use Role for govt: ensuring they are not overused

A good is excludable if someone can be prevented from using it. A good is rival in consumption if one person's use reduces others' ability to use the same unit of the good.

Markets work best for private goods, which are excludable and rival in consumption. Markets do not work well for other types of goods.

public goods

Public goods are difficult for private markets to provide because of the free-rider problem. Free rider: a person who receives the benefit of a good but avoids paying for it If good is not excludable, people have incentive to be free riders, because firms cannot prevent non-payers from consuming the good. Result: The good is not produced, even if buyers collectively value the good higher than the cost of providing it.

policy options to prevent overconsumption of common resources

Regulate use of the resource Impose a corrective tax to internalize the externality Example: hunting & fishing licenses, entrance fees for congested national parks Auction off permits allowing use of the resource Example: spectrum auctions by the U.S. Federal Communications Commission If the resource is land, convert to a private good by dividing and selling parcels to individuals

example of a good: road

Rival in consumption? Only if congested. Excludable? Only if a toll road. Four possibilities: Uncongested non-toll road: public good Uncongested toll road: club good Congested non-toll road: common resource Congested toll road: private good

shutdown vs exit

Shutdown: A short-run decision not to produce anything because of market conditions. Exit: A long-run decision to leave the market. A key difference: If shut down in SR, must still pay FC. If exit in LR, zero costs.

spam case study

Some firms use spam e-mailsto advertise their products. Spam is not excludable: Firms cannot be prevented from spamming. Spam is rival: As more companies use spam, it becomes less effective. Thus, spam is a common resource. Like most common resources, spam is overused - which is why we get so much of it!

the irrelevance of sunk costs

Sunk cost: a cost that has already been committed and cannot be recovered Sunk costs should be irrelevant to decisions; you must pay them regardless of your choice. FC is a sunk cost: The firm must pay its fixed costs whether it produces or shuts down. So, FC should not matter in the decision to shut down.

corrective taxes are better for the environment

The corrective tax gives firms incentive to continue reducing pollution as long as the cost of doing so is less than the tax. If a cleaner technology becomes available, the tax gives firms an incentive to adopt it. In contrast, firms have no incentive for further reduction beyond the level specified in a regulation.

why monopolies arise

The main cause of monopolies is barriers to entry—other firms cannot enter the market. Three sources of barriers to entry: 1. A single firm owns a key resource. E.g., DeBeers owns most of the world's diamond mines 2. The govt gives a single firm the exclusive right to produce the good. E.g., patents, copyright laws Natural monopoly: a single firm can produce the entire market Q at lower cost than could several firms.

tragedy of commons

The tragedy is due to an externality: Allowing one's flock to graze on the common land reduces its quality for other families. People neglect this external cost, resulting in overuse of the land.

Public goods, such as national defense and fundamental knowledge, are neither excludable nor rival in consumption. Because people do not have to pay to use them, they have an incentive to free ride, and firms have no incentive to provide them.

Therefore, the government provides public goods, using cost-benefit analysis to determine how much to provide.

corrective taxes and subsidies

a corrective tax is a tax designed to induce private decision makers to take account of the social costs that Arise from a negative externality -also called pigouvian taxes after Arthur pigou

negative externalities

air pollution from a factory neighbors barking dog late night stereo blasting from dorm room next to yours noise pollution from construction projects health risk to others from second hand smoke talking on cell phone while driving makes roads less safe for others

the socially optimal Q maximizes welfare

at any lower Q the social value of additional units exceeds their cost at any higher Q the cost of last unit exceeds is social value

examples of positive externalities

being vaccinated against contagious diseases protects not only you, but people who visit the salad bar or produce section after you R&D creates knowledge others can use people going to college raise the populations education level, which reduces crime and improves government

important common resources

clean air and water, congested roads, fish/whales/wildlife

other taxes and subsidies distort incentives and move economy away from the social optimum

corrective taxes and subsidies align private incentives with society's interests, make private decision-makers take into account the external costs and benefits of their actions, and move economy toward a more efficient allocation of resources

externalities can be negative or positive

depending on whether impact on bystander is adverse or beneficial

for activities with positive externalities. ideal corrective subsidy=

external benefit

ideal corrective tax=

external cost

coase theorem-private solution to externality

if private parties can costlessly bargain over the allocation of resources, they can solve the externalities problem on their own ex: mark owns a dog named spot negative externality: spot barking disturbs Jessica, marks neighbor -socially efficient outcome maximizes mark+Jessica well being (if mark bales having spot more than Jessica values peace and quiet, the dog should stay) ---privat market reaches efficient outcome on its own

an externality occurs when a market transaction affects a third party

if the transaction yields negative externalities such as pollution the market quantity exceeds the socialy optimal quantity

monopoly

is a firm that is the sole seller of a product without close substitutes. "A monopoly is either what the government says it is or what a dominant company's competitors claim. The government's opinion is the only one that counts..." (247wallst.com)

characteristics of perfect competition

many buyers and many sellers -goofd offered for sale are largely the same -firms can freely enter/exit market because of 1 and 2 each buyer and seller is a price taker-takes the price as given

imposing the tax on buyers would achieve the same outcome

market Q would qual optimal Q

when market participants must pay social costs

market equilibrium=social optimum

if negative externality

market quantity larger than socially desirable

if positive externality

market quantity smaller than socially desirable

governments can sometimes improve market outcomes

markets are usually a good way to organize economic activity

important public goods

national defense, knowledge created through basic research, fighting poverty

different kinds of goods

private goods-excludable, rival in consumption ex:food public goods: not excludable, not rival ex: national defense common resources: rival but not excludable ex: fish in the ocean club goods: excludable but not rival ex: cable tv

for both goods and common resources, externalities arise bc something of value has no price attached to it

so private decisions about consumption and production can lead to an inneficcient outcome, public policy can potentially raise economic well being

self interested buyers and sellers neglect the external costs or benefits of their actions

so the market outcome is not efficient

example of corrective tax: the gas tax

targets 3 negative externalities: -congestion-the more you drive the more you contribute to congestion -accidents-larger vehicles cause more damage in an accident -pollution-burning fossil fuels produces greenhouse gases

to remedy the problem we "internalize the externality" by

taxing goods with negative externalities subsidizing goods with positive externalities

in the absence of market failures

the competitive market outcome is efficient, maximizes total surplus

if the externality is positive such as technology spillovers,

the market quantity falls short of the social optimum

in the presence of positive externalities

the social value of a good includes- private value (direct value to buyers) and external benefit-(value of positive impact on bystanders)

one type of market failure is an externality

the uncompensated impact of one persons actions on the well being of a bystander

public goods tend to be under provided while common resources tend to be over consumed

these problems arise bc property rights are not well established -nobody owns the air so no one can charge polluters,-so too much pollution -nobody can charge people who benefit from national defense so-too little defense -the government can potentially solve this w appropriate policies

private solutions to externalities

types of private solutions: -moral codes and social sanctions-golden rule -charities -contracts between market participants and the affected bystanders

the private market may fail to provide the socially efficient quantity of such goods

when goods. have no prices the market forces that normally allocate resources are absent