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.
What does it mean for a good to be rival in consumption?
one person’s use of it diminishes other people’s use of it.
How does non excludability lead to inefifcient allocation?
Price is a signal that tells seller how much buerys value it and buyers how much sellers take to produce it
When goods have no prices,
the market forces that normally allocate resources are absent.
What is rival and non excludable?
Common resources
What is not rival and excludable?
Club good/ Natural monopoly
How do public goods arise?
Non excludable: people have incentive to free ride
Firms do not produce good even if the cost of providing the good is less than the collective benefit of good
How do common resources arise?
Non excludable:
free rider cannot be stopped from using, firms dont provide. GOVT HAVE TO PROVIDE
Rivalrous:
each person use reduces others ability to use it
GOVT ENSURE THEY ARE NOT OVERUSED
What does the tragedy of the commons show? How to solve?
shows why common resources overused
Negotiated agreements (players just need to find a way to align their individual incentives with the goals of the group as a whole)
What are govt policies to prevent overconsumption of common resources?
Privatise
Regulate
Corrective tax
Permit
What is the profit maximisation condition?
Produce as long as MR>=MC
What are the formulas for Total revenue, average revenue and maginal revenue?
TR= P x Q
AR= TR/Q = P
MR = dTR/dQ
What is marginal revenue?
change in Total Revenue from an additional unit sold
When is ATC falling?
MC<ATC. mc is pulling down atc
(WHETHER ATC RISES OR FALLS DEPEND ON COST STRUCTURE)
When is ATC rising?
MC>ATC. mc is pulling up atc
(WHETHER ATC RISES OR FALLS DEPEND ON COST STRUCTURE)
Where do ATC and MC intersect and why?
ATC curve’s minimum.
If mc is neither pulling up nor pulling down atc, then intersect is at minimum of atc
waht and why is the profit max quantity?
Thinking on the margin, if increase q by 1 unit, revenue incerase by mr, cost increase by mc.
If MR > MC, then increase Q to raise profit.
If MR < MC, then decrease Q to raise profit.
What are the characteristics of perfect compeittion?
There are many buyers and sellers, causing each buyer or seller is too small to influence the entire market
Sellers offer a standardized product.
Sellers can freely enter or exit the market.
Buyers and sellers are well-informed.
buyer and seller is a price-taker
Why does P=mc for perfect comp?
competitive firm can keep increasing its output without affecting the market price.
each unit increase in Q causes revenue to rise by P,
i.e., MR = P.
Why is the compeittive market producing at efficeitn qty?
Since MC=MR and P=MR, P=MC
MC is the cost of producing the marginal unit.
P is the value to buyers.
So, the competitive equilibrium is efficient; it maximizes total surplus.
A firm’s marginal cost of producing a good always equals the price of the good
True or false
FALSE(Depeneds on the firms cost structure)
A firms marginal revenue from selling a good always equal to the price of the good
True or False
False
In prisoner Dilemma both players have _____ that lead to ______ outcomes
Dominant strategies
Inefficient
