Chapter 12 Flashcards
Pareto improvement
where changes in production or consumption can make at least one person better off without making anyone worse off.
Social efficiency
a situation of pareto optimally.
Pareto optimally
where all possible pareto improvements have been made; where, therefore, it’s is impossible to make anyone better off without making someone else worse off.
Rational economic behavior
doing more of those activities whose marginal benefits exceeds their marginal cost and doing less of those activities whose marginal cost exceeds their marginal benefit.
Private efficiency
where a person’s marginal benefit from a given activity equals the marginal cost.
Total producer surplus
total revenue minus total variable costs (TR-TVC): total profit plus fixed costs (TII +TFC). Producer surplus is the area between price and the MC curve.
General equilibrium
where all the millions of markets throughout the economy are in a simultaneous state of equilibrium.
Total private surplus
total consumer surplus (TU-TE) plus total producer surplus (TR-TVC).
Provided the two conditions of perfect competition and the absence of externalities, pareto optimal will be achieved.
Total social surplus
total benefits to society from consuming a good minus total cost of society from producing it. In the absence of externalities, total social surplus is the same as total (private) surplus.
External benefits
benefits from production experienced by people other than the producer directly involved in the transaction.
External costs
costs of production experienced by people other than the producer directly involved in the transaction.
Social cost
private cost plus externalities in production.
Social benefit
private benefit plus externalities in consumption.
Four types of externalities:
- External costs of production (MSC > MCP) with no external cost/benefit of consumption.
Socially optimal output = the output where MSC = MSB: the output where total social surplus is maximized.
Deadweight welfare loss = the loss of social surplus at the competitive market equilibrium compared with the social optimum where MSC = MSB.
Social surplus = total social benefits minus total social costs.
One of the reasons why external costs cause problems in a free-market economy is because no one has legal ownership of factors such as the air or rivers. Therefore, no one has the ability ether to prevent or to charge their use as a dumping ground for waste. Control must therefore be left to the government, local authorities or regulators.
- External benefits of production (MSC < MPC) with no external costs/benefits of consumption.
- External costs of consumption (MSB < MPB) with no external costs/benefits of production (MSC = MPC) – drinking alcohol.
- External benefits of consumption (MSB > MPB) with no external costs/benefits of production (MSC = MPC) – using trains instead of cars.
Public good
a good or service that has the features of non-rivalry and non-excludability and as a result would not be provided by the free market.
Non-rivalry
where the consumption of a good or service by one person will not prevent others from enjoying it.
Perfectly rivalrous goods – the good gets used up as it is consumed.
Perfectly non-rivalrous goods – turning on the television.
Goods with a degree of rivalry and non-rivalry – internet access.
Non-excludability
where it is not possible to provide a good or service to one person without it thereby being available free for others to enjoy.
Easily excludable goods
only those people who paid for the good are able to enjoy it. (Netflix)
Perfectly non-excludable goods
if it is too costly or simply not feasible to implement a system that would effectively prevent those people who have not paid from enjoying the benefits it provides. (fishing in the ocean)
Pure private good
one where the benefits can be enjoyed only by the consumer who owns it.
Pure public good
a good or service that has the characteristics of being perfectly non-rival and completely non-excludable and would not be provided by the free market. (national defense)
Impure public goods
a good that is partially non-rivalrous and non-excludable.
Club good
a good which has a low degree of rivalry but is easily excludable. (Netflix)
Common goods or resource
a good or resource that has a high degree of rivalry, but the exclusion of non-prayers is difficult. (fishing in the ocean)
Tragedy of the commons
when resources are commonly available at no charge, people are likely to overexploit them.
Free-rider problem
when it is not possible to exclude. Other people from consuming a good that someone has bought.
Deadweight welfare loss of monopoly
the loss of consumer plus producer surplus in monopoly or other imperfect markets (when compared with perfect competition).
asymmetric information.
One form of imperfect information occurs when different sides in an economic relationship have different amounts of information
Merit goods
goods that the government feels people will under consume and which therefore ought to be subsidized or provided free.
Problem of the second best
the difficulty of working out the best way of correcting a specific market distortion if distortions in other parts of the market continue to exist.
First-best solution
the solution of correcting a specific market distortion by ensuring that the whole economy operates under conditions of social efficiency (pareto optimality).
Second-best solution
the solution to a specific market distortion that recognizes distortions elsewhere and seeks to minimize the overall distortionary effects to the economy of tackling this specific distortion.
Taxes and subsidies can be used for two main microeconomic purposes:
To promote greater social efficiency by altering the composition of production and consumption.
To redistribute incomes.
Pigouvian tax
a tax designed to internalize an externality. The marginal rate of a Pigouvian tax should be equal to the marginal external cost/benefit. A distortion should be corrected at source if side-effect problems are to be avoided.
Taxes and subsidies to correct externalities
The first-best solution when there is only one market imperfection: Pigouvian tax (or subsidy)
Second-best tax and subsidies policies – will seek the best compromise that minimizes the relative distortions between the industry in question and other parts of the economy.
Lump-sum tax
a tax in which the taxpayer is assessed the same amount regardless of circumstances. > fixed costs.
Advantages of taxes and subsidies:
Forces firms to take on board the full social costs and benefits of their actions – internalizing the externality.
Once the policy is in place, taxes and subsidies can be adjusted according to the magnitude of the problem.
If firms are taxed for polluting, they are encouraged to find cleaner ways of producing.
Disadvantages of taxes and subsidies
Infeasibility of using different tax and subsidy rates.
Lack of knowledge.
Coase theorem
When there are well-defined property rights and zero bargaining costs, then negotiations between the party creating the externality and the party affected by the externality can bring about the socially efficient market quantity.
Advantages of legal restrictions:
They are simple and clear to understand and are often relatively easy to administer.
When the danger is very great, it might be much safer to ban various practices altogether rather than to rely on taxes or on individuals attempting to assert their property rights through the civil courts.
When a decision needs to be taken quickly, it might be possible to invoke emergency action.
Disadvantages of legal restrictions:
Main problem: legal restrictions tend to be a rather blunt weapon.
