lecture 20 (part 2) and 21 Flashcards
when can we expect markets no to work well? (market failure)
market failure → when markets do wolt work well
ex: monopoly
- In a market, prices are the main instruments to get allocations
when do markets produce inefficient outcomes?
- when there are relevant effects not captured by prices, decisions may not lead to efficient allocations
What can government policies do about market failure?
- public policies designed to adress market failure
what are externalities?
- and effect related to the productions or consumptions of a good that falls on people who are not the producers or consumers
- that is, the effect of a production, consumption, or other economic decision on another person, who is not directly involved in the market of this good or service
- can be positive or negative
what is a negative externality?
- the effects on those outside the market are bad
- there is an external cost
- can result from either the consumption or the production of a good (or both)
examples: - pollution from driving
- second-hand smoke from cigarretes
- …
how do you analyze externalities?
- expand the concept of marginal cost and marginal benefit to include costs and benefits on people outside the market
- “private”, refers to people participating in the market (the buyers and sellers)
- “social”, includes effects on people both in the market and outside the market
what is the review of welfare analysis when exists PMC (private marginal cost) and PMB (private marginal benefit)?
- consumer surplus (CS) → area betwwen PMB and the market price, up to the quantity produced
- producer surplus (PS) → area between the market price and PMC, up to the quantity produced
- total private surplus → sum of consumer surplus and producer suplus
- that is, the area between the PMB and PMC, up to the level produced and consumed
what is external marginal cost?
- the additional cost to people outside the market when one more unit is produced and consumed
what is social marginal cost?
private marginal cost plus external marginal cost
what is a total social surplus?
- total private surplus plus external benefits minus external costs
- it includes the welfare of both people in the market and outside the market
when is the total social surplus as large as possible?
- where SMB=SMC
- because, any shortfall from the largest total social surplus is the deadweight loss
- but the market produces PMB=PMC
- when there is no externality, SMB is the sames as PMB and SMC is the same as PMC
so PMB=PMC is the same as SMB=SMC
what are the key points about negative externality?
- SMC curves lies above the PMC curve
- the people in the market will choose to produce where PMB=PMC ( or supply=demand)
- but society would be better of if the market produced and consumed less (where SMB=SMC)
what is a positive externality?
- the effect on those outside the market are good
- external benefit
- can result from either the consumption or the production of a good (or both)
what is external marginal benefit?
the additional benefit to people outside the market when one more unit is produced and consumed
what is social marginal benefit
private marginal benefit plus external maginal benefit
what are the key points about positive externalities?
- the SMB curve lies above the PMB curve
- the people in the market will choose to produce where PMC=PMB (or supply=demand)
- but society would be better off if the market produced and consumed more (where SMC=SMB)
What are the remedies for externalities?
- private solution:
- negotiation and compensation
- social sanctions
- government interventions:
- regulation → limit the quantity produced or consumed (similar to quota)
- compensation → the government can require those imposing costs on others to compensate the individuals who are suffering the external negative effects
- Taxes and subsidies → they force the decision maker to recognize the external cost (or benefits) associated with the production or consumption of a good
How to choose and think about different solutions?
- fairness concern
- efficiency
- feasibility → some solutions require haviing information that may not be easy to gather
- quantity constraint → requires us to know bothe the demand and SMC curve, to find where they cross
- technology regulation → requires us to know the “best” way to produce
- tax (subsidy) → requires us to know the external marginal cost (external marginal benefit)
- compensation → requires us to be able to measure the externallity and to find those who were affected
what are positional externalities (or status goods)?
- goods that confer status valued only by how they are distributed among the population
- normally total supply is (naturally or not) restricted
- ex: gold, luxury goods, real estate
what are positional externalities?
- new purchases lower the value of existing positional goos
what policies can help with positional externalities?
- pigouvian taxes on luxury goods
- higher income taxes
- directly limit consumption of these goods
