Topic 4 - Markets, Externalities, and Public Goods (1) Flashcards
What’s the difference between efficiency and social efficiency?
Efficiency is obtained when MB=MC; social efficiency is obtained when MSB=MSC.
Social efficiency requires all market and non-market values to be incorporated into the values of social benefits and costs.
Competitive Market - what is it and what are the requirements of a perfectly competitive market?
Competitive market is a market where no producer has a direct impact on the prices of goods, making all producers and consumers price takers.
Assumptions of a competitive market include: that there are many buyers and sellers, all firms sell identical product, all firms can freely enter or exit the market, and that sellers and buyers are well informed about the prices.
Shortage vs Surplus in Market
Shortage occurs when quantity demanded is greater than the quantity supplied, and,
Surplus occurs when quantity supplied is greater than the quantity demanded.
Law of Supply and Demand
Price of a good will naturally adjust to bring the quantity supplied and quantity demanded into balance for that good.
Follows the invisible hand principle.
Consumer Surplus
The difference between the maximum price consumers are willing to pay for a good and the actual price they pay for said good. Measured by the area underneath the demand curve, and above the price line.
Producer Surplus
The difference between the lowest price producers are willing to accept for a good and the price they actually receive. Measured by the area above the supply curve and underneath the price line.
Net Benefits
Measured by total surplus, which is the sum of the producer and consumer surplus.
Efficiency
The property of resource allocation in a way that maximizes total surplus received by all members in society.
Occurs when MB=MC
Pareto Optimal
A situation where it is impossible to make any other person better off without making someone else worse off; essentially an efficient equilibrium.
Equity
The fairness of the distribution of well-being amongst all members of society.
When are net benefits maximized?
Net benefits are maximized when MSB=MSC
Efficient Market Assumptions
Perfect competition (MB=MC), perfect information, and no externalities.
Violation of any of the assumptions leads to market failure.
Market Failure
A situation in which a market fails to produce an efficient level of output.
Can be caused by imperfect competition, imperfect information, externalities, and public goods.
Externality
An external cost or benefit received by someone who is not directly involved in the consumption or production of a good or service.
A negative externality imposes a cost, a positive externality creates a benefit.
Four Types of Externalities
- Negative production externality - burning coal to generate production activity emits carbon dioxide.
- Positive production externality - a fruit grower helps beekeepers by providing bees with pollen from their fruit trees.
- Negative consumption externalities - smoking cigarettes, affecting those nearby.
- Positive consumption externalities - when you get a flu vaccination, others around you benefit.
Private Cost and Marginal Private Cost
Private cost is a cost paid by a producer or consumer of a good.
MPC is the cost of consuming or producing one additional unit of a good or service.
External Cost and Marginal External Cost
External cost is a cost paid by bystanders, people other than producers or consumers.
MEC is the cost incurred by a bystander when producers or consumers produce or consume one additional unit of a good or service.
Social Cost and Marginal Social Cost
Social cost is the cost paid by the entire society when goods are consumed or produced.
MSC is the cost incurred by the entire society when one additional unit of a good or service is consumed or produced.
MSC is the sum of MEC and MPC.
Social Surplus
Sum of the producer surplus, consumer surplus, and social surplus.
What happens to equilibrium when not accounting for negative externalities?
MSC will slant the MPC curve more vertically, creating a deadweight loss when produced at the original equilibrium.
When company produces at that original equilibrium, they are overproducing, and incurring deadweight loss.
Q-market > Q-optimal
Private Benefit and MPB, External Benefit and MEB, and MSB
Private benefit is the benefit received by a producer or consumer of a good; MPB is the benefit received from producing or consuming one more additional unit of a good or service received by a consumer or producer of a good.
External benefit is the benefit received by a bystander, someone other than producer or consumer; MEB is the benefit received by someone other than producer or consumer when one additional unit of a good or service is produced or consumed.
MSB is the marginal benefit received by the entire society when an additional unit of a good or service is consumed or produced; summation of MPB and MEP
What happens to equilibrium when not accounting for positive externalities?
The MSB curve will slant the MPB curve more vertically, creating a deadweight loss when produced at the original equilibrium.
When company produces at the original equilibrium, they are underproducing and incurring a deadweight loss.
Q-market < Q-optimal
