Chapter 10: Markets, contracts and information Flashcards
Firms with little competition do/ are what?
They are monopolists or those producing differentiated goods—set their prices above marginal cost.
Results of monopolies over charging for their goods sold on markets
The price at which the good is sold then sends the wrong message: The high price overstates the real scarcity of the good as indicated by its marginal cost.
Result of allocation of goods within monopolies
The resulting allocation is not Pareto efficient: Too little is sold, so there is a deadweight loss
Firms in competitive markets are…
firms in competitive markets are price-takers: They produce where price is equal to marginal cost, and the allocation maximises the total surplus of the buyers and sellers.
For a market to work well (and sometimes event exist) what is required?
other social institutions and social norms are required. Governments, for example, provide a system of laws and law enforcement that allow markets to function effectively, by guaranteeing property rights and enforcing contracts. Social norms dictate that you respect the property rights of others, even when enforcement is unlikely or impossible.
Social dilemma example
Overuse of antibiotics.
when the unregulated pursuit of self-interest leads to outcomes that are Pareto inefficient. Bacteria become resistant to antibiotics when we use them too often, in the wrong dosage or for conditions that are not caused by bacteria. In India, for example, antibiotics are easily available over the counter in pharmacies without a doctor’s prescription.
Doctors recognise that leaving the allocation of antibiotics to the market is having damaging consequences. On the advice of unlicensed private medical practitioners, people use antibiotics when other treatments would be better. To save money, the patients often stop taking the antibiotics when they feel a little better. This is exactly the pattern of use that will produce antibiotic-resistant pathogens. But, for the patient, the treatment worked, and the unlicensed doctor’s business will prosper.
When the market allocation of a good/ service is pareto inefficient we have a…
market failure
In the case of antibiotics this happens because the decisions of the buyers and sellers also have costs or benefits for other people that the decision makers do not take into account. Future users of antibiotics are put at risk from resistant bacteria. Such an effect is known as an external effect.
Marginal external cost formula
Marginal external cost = Marginal Social Cost - Marginal Private Cost
Pigouvian tax
A tax levied on firms generating negative external effects so as to correct an inefficient market outcome. This type of tax is named after the economist Arthur Pigou. See also: External effect.
Positional good
A good for which one person having more necessarily implies another having less.
e.g. cars, designer clothes etc
Veblen effect
People care not only about what they have, but also about what they have relative to what other people have. Named after Thorstein Veblen, an economist and sociologist.
Asymmetric information
Information that is relevant to the parties in an economic interaction, but is known by some but not by others.
Ways to take into account Marginal Social Cost
- Regulation of the amount of products produced
- Taxation of the production or sale of a product
- Enforcing compensation of the party that lost out for the costs imposed on them
- Coasian bargaining
Pareto efficiency and profit maximisation on MSC and MPC curves
the pareto efficienct outcome is the crossover between optimal price and MSC
whereas the profit maximisation curve (for the producer of the product is the price crossover with the MPC
NB: MPC = Marginal private cost
MSC = Marginal social cost
Tax is equal to what?
Tax = MSC - MPC which is also equal to Marginal external cost as….
Marginal extermal cost = Marginal social cost - Marginal private cost
at the pareto efficient quantity.
If a government puts a tax on each tonne of a given product produced. it should equal the difference between the social cost and price of the product.. Thus, compensating for social externalities.
So, a company will choose their output so that the MPC is equal to the after tax price (crossover between MPC and after tax price at the pareto efficient output.
