W6 Flashcards
What is a market?
- an economic insitution that allows for the pursuing of private objectives to efficiently produce and allocate goods and services
- they have foundations resulting from social institutions and other social norms eg. laws guarantee property rights and the enforcement of contracts
- allows for many different individuals globally interact for mutual gain
Are markets pareto efficient?
Not necessarily pareto efficient or the best outcome
- there can be market failures
- asymmetric information - this is critical
What are the two things that market allow for?
specialisation and division of labour
- faster learning by doing
- greater economies of scale
What is a price signal?
prices can signal the scarcity - prices up- or excess - prices down of g/s in the market
- in competitive markets the price= marginal costs - which signals the cost to society of producing a good
What is the relationship between price and marginal costs?
In a competitive market price = marginal cost
but the price may fail to reflect the social marginal cost
- if there is a lack of competition P>MC
- if there are external effects P><SMC
i.e. positive or negative externalities
What are the sources of market failure
- incomplete contracts
- missing/incomplete/asymmetric information
- externalities/moral hazards/adverse selection
What is an external cost?
a negative effect of an economic decisision that is not accounted for in the contract
eg. the adverse effect of pesticide use by a banana plantation on the fishing industry on an island
In an externality situation what is the relationship between marginal social cost and marginal private costs?
MSC>MPC
you are producing more than the socially optimal quantity
What would a negative externality in PRODUCTION graph look like?
Supply and deamd curves etc.
Supply curve MSC>MPC - i.e further to the left
there would be a deadweight loss at the current quantitity produced - ABOVE the SMC line
MARKET QUANTITIY WOULD BE LARGER THAN IS SOCIALLY DESIRABLE
eg. pollution
What would a positive externality in CONSUMPTION look like?
Supply and deamd curves etc.
Supply curve MSC>MPC - i.e further to the left
there would be a deadweight loss at the current quantitity produced - BELOW the SMC line
MARKET QUANTITY IS SMALLER THAN SOCIALLY DESIREABLE
eg. renewable energy production
What is the marginal social cost made up of?
MSC= MPC+MEC
marginal social cost = marginal private costs + marginal external cost
What is the marginal social benefit made up of?
MSB= MPB+MEB
marginal social benifit = marginal private benefit + marginal external benefit
What relationship between marginal social cost and marginal social benefit creates a pareto efficient situation?
MSC= MSB
you can consume or increase a good as long as MSB>MSC
What is a private decision?
Decesisions that do not take into account external benefits or costs
What is a private market?
these are not always pareto efficient … MPC=/= MPB
Why might coasean bargaining not work?
- transaction costs = cost of acquiring information, enforcing a contract or collective action
- missing information = measurement in agg and for each party - origin of the pollutant
- readability and legal enforcement
- limited funds
-fairness - eg. polluter pays principle
What are the three possible solutions to this issue of externalities?
- regulation of the product to only produce the socially optimal amount
- Pigouvian tax - tax on firms generating negative external effects, in order to correct an inefficient market outcome
- enforcing compensation for affected parties - here the compensated party rather than the government that gets the payment eg. pay for clean transition
What is an example of a pigouvian tax?
eg. petrol tax - taxes drivers for the negative externality associated with driving petrol cars
What is the potential downfalls of a pigouvian tax?
the degree of harm is uncertain
the marginal costs are difficult to measure
government may favour powerful groups
What is a pigouvian tax?
a tax on firms generating negative external effects in order to correct an inefficient market outcome
MSB>MPB
the government takes part of the pie - the bit between the new price including the tax and the original price
the tax price is lower than the original price because the producers are receiving less for their products rather than more
What would a tax on producers look like in a demand curve?
Say the tax moves from the MPC to the MSC
the new point of equilibrium could be at the point where demand reaches that MPC
there would be a deadweight loss due to the shift in quantity produced
the surplus would go to the government - the different in the price square with the reduced quantity
What would happen if consumers were taxed?
Demand for the products would reduce and shift down - there would be a deadweight loss again and quantity produced would be reduced
Does it matter who or how you tax?
not in theory but in practice it might - people don’t like taxes
What are the risks associated with governments introducing regulation?
- costs may differ between firms and or different consumers
- political costs of being regulation-heavy government
but good if you want to just ban something outright like the LED lightbulb example
