Lecture 5 Flashcards
What is the first fundamental theorem of welfare economics?
- There are markets and market prices for all goods
- All buyers and sellers are competitive price-takers
- Each person’s utility depends only on his own consumption
Give 2 ways of how markets can fail
- Markets are not perfectly competitive (Buyer or seller has market power)
- transactions have externalities
What is an externality?
A byproduct of consumption or production that affects someone other than the buyer or seller
can be posititive or negative, depending on whethe rhte impact on the bystander is adverse or beneficial
How does externalities make markets inefficient?
what matters is social cost and benefits ( private + external cost and benefits)
self-interested buyers and sellers consider only private cost and benefits of their actions; they neglect the external costs of benefits of thei actions
Structure for explainingn market failure in petrol
- Market eqm maximises consumer surplus anad producer surplus
- Supply curve shows Private marginal cost(PMC) (cost directly incurred by sellers)
- Supply curve shows Private marginal benefit (PMB)
- Social marginal cost is higher than the supply curve by external marginal cost (EMC). EMC represents the value of negative impact to bystanders
- Only consider the private benefit and cost.
- Market eqm greater than social optimum
Why must a tax be imposed on negative externality?
to INTERNALIZE THE EXTERNALITY
must introduce a tax that exactly equals to the EMC
Why is social marginal benefit greater than the private marginal benefit?
Due to presence of external marginal benefit
At every quantity, sum of the marginal private benefit and the external marginal benefti gives us the social marginal benefit
What are the 2 types of public policy for externalities?
Command- and-control poliicies to regulate behaviour directly ( eg limit amt of pollution)
market based policies (incentives to take external into acc like tax and sub)
What are corrective tax?
Pigouvian Tax
shift supply or demand curve wrt to amount of tax
What are the purpose of corrective tax and subsidy?
align private incentives with society’s interests
induce private decision-makers to take into account the external costs and benefits of their actions
move the economy toward a more efficient allocation of resources
NEGATIVE: seller see higher cost
POSITIVE: buyer have higher valuation of good
What is coase theorem?
If private parties can costlessly bargain over allocation of resources, they can solve the externalities problem on their own.
Depends on who has the right (eg sibling want to disturb you, vs want to have peace)
What is the outcome of coase theorem?
The socially efficient outcome maximizes both Jack’s and Jill’s well-being.
the _____ market achieves __ outcome regardless of initial distribution of rights
private
efficient
Why do private solutions not always work?
Transaction costs
Stubbornness
Coordination problems ( larger parties make coordinating difficult)
What does it mean for a good to be excludable?
person can be prevented from using it.
