lecture 20 (part 2) and 21

Question 1

when can we expect markets no to work well? (market failure)

Answer 1

market failure → when markets do wolt work well
ex: monopoly
- In a market, prices are the main instruments to get allocations

Question 2

when do markets produce inefficient outcomes?

Answer 2

• when there are relevant effects not captured by prices, decisions may not lead to efficient allocations

Question 3

What can government policies do about market failure?

Answer 3

• public policies designed to adress market failure

Question 4

what are externalities?

Answer 4

• 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

Question 5

what is a negative externality?

Answer 5

• 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
• …

Question 6

how do you analyze externalities?

Answer 6

• 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

Question 7

what is the review of welfare analysis when exists PMC (private marginal cost) and PMB (private marginal benefit)?

Answer 7

• 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

Question 8

what is external marginal cost?

Answer 8

• the additional cost to people outside the market when one more unit is produced and consumed

Question 9

what is social marginal cost?

Answer 9

private marginal cost plus external marginal cost

Question 10

what is a total social surplus?

Answer 10

• total private surplus plus external benefits minus external costs
• it includes the welfare of both people in the market and outside the market

Question 11

when is the total social surplus as large as possible?

Answer 11

• 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

Question 12

what are the key points about negative externality?

Answer 12

• 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)

Question 13

what is a positive externality?

Answer 13

• 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)

Question 14

what is external marginal benefit?

Answer 14

the additional benefit to people outside the market when one more unit is produced and consumed

Question 15

what is social marginal benefit

Answer 15

private marginal benefit plus external maginal benefit

Question 16

what are the key points about positive externalities?

Answer 16

• 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)

Question 17

What are the remedies for externalities?

Answer 17

• 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

Question 18

How to choose and think about different solutions?

Answer 18

• 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

Question 19

what are positional externalities (or status goods)?

Answer 19

• 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

Question 20

what are positional externalities?

Answer 20

• new purchases lower the value of existing positional goos

Question 21

what policies can help with positional externalities?

Answer 21

• pigouvian taxes on luxury goods
• higher income taxes
• directly limit consumption of these goods