2- Market Efficiency

What is a supply schedule?

The relationship between price and the quantity producers are willing to sell; supply price reflects the marginal cost of producing one more unit

What is a demand schedule?

The relationship between price and the quantity consumers are willing to buy; demand price reflects the marginal benefit of consuming one more unit.

The relationship between price and the quantity consumers are willing to buy; demand price reflects the marginal benefit of consuming one more unit.

The difference between what producers receive from selling a good and the cost of producing it. It is a measure of producer welfare

What is consumer surplus?

The difference between what consumers are willing to pay and what they actually pay. It is a measure of consumer welfare

What is social surplus?

The sum of consumer surplus and producer surplus.

When is a market said to be efficient?

When social surplus is maximized, which is characterized by supply equaling demand.

Why can a monopoly lead to inefficiency?

Because maximizing producer profit does not maximize social surplus; monopoly output is not generally the socially optimal quantity.

What is an externality?

An external benefit or cost not accounted for in the market, causing inefficiency and preventing social welfare from being maximized.

How do external costs affect social surplus?

If external costs are ignored, the apparent social surplus is overstated; the true social surplus is lower because external damage must be subtracted.

If external costs are ignored, the apparent social surplus is overstated; the true social surplus is lower because external damage must be subtracted.

It sets marginal benefit equal to private marginal cost, Pc​=Pp​, instead of including external costs.

What condition defines an efficient market with externalities included?

Marginal benefit equals private marginal cost plus marginal external cost, Pc=Pp+Pe

What is a Pigouvian tax?

A tax designed to internalize an external cost so that the market produces the efficient quantity.

What is the main benefit of a Pigouvian tax?

It forces a reduction in production to the efficient level.

What are two limitations of a Pigouvian tax?

It is hard to quantify marginal external cost correctly, and it assumes externalities are reduced only by lowering production rather than by changing the production process.

What are three alternative environmental policy options mentioned in the lecture?

Private ownership, command-and-control regulation, and pollution permit trading.

 Private ownership, command-and-control regulation, and pollution permit trading.

If a good is properly and completely owned, an efficient market equilibrium can arise even with externalities, regardless of who owns the good.

What are the key assumptions behind the Coase Theorem?

hat are the key assumptions behind the Coase Theorem?

What is command-and-control regulation?

Environmental regulation based on standards that specify how things should be.

What are the three main types of command-and-control standards?

Ambient standards, emission standards, and technology standards.

What is a disadvantage of command-and-control regulation?

What is a disadvantage of command-and-control regulation?

What is pollution permit trading?

What is pollution permit trading?

What choices do firms have under pollution permit trading?

Use permits and abate extra emissions, buy more permits, or sell permits and reduce emissions further.

What is the equimarginal principle of optimality?

The environmental target is met at minimum cost when each polluter abates until marginal abatement costs are equal across firms.

What is total abatement cost for two polluters?

It is the sum of each polluter’s abatement costs: Sar=Sa1+Sa2

What condition minimizes total abatement cost for two polluters?

Their marginal abatement costs must be equal, Pa1=Pa2