U2 ECON

postive externality

When an activity helps others, but the person doing it isn't compensated.

Concept: People will engage in too little of this activity because they only consider their own gain, not the total gain to society.

Negative Externality (External Cost):

When an activity hurts others, but the person doing it doesn't pay for the damage.

• Concept: People will engage in too much of this activity because they don't have to pay for the "social cost."

The "Invisible Hand" Failure:

leads to social efficiency, but when externalities exist, self-interested actions lead to inefficient outcomes because the "hand" becomes "invisible" to the true costs/benefits.

Coase Theorem:

If people can negotiate with each other at no cost, they will always find an efficient solution to an externality, regardless of who holds the legal rights.

Socially Inefficient Outcome:

An outcome where the total economic surplus is not maximized

Liability Independence:

The Coase Theorem implies the same efficient outcome will be reached whether the polluter is liable or not.

• Income Impact:

While the "efficiency" is the same, the wealth is different. If the polluter is liable, they end up poorer; if they aren't, the victim ends up poorer because they have to pay the polluter to stop.

Reservation Price:

The maximum amount someone is willing to pay to avoid a negative situation or gain a positive one.

Economic Surplus:

The difference between the maximum one would pay and what they actually pay.

Surplus Sharing: For a voluntary agreement (like roommates) to work, both parties must be better off than they would be alone.

Zoning Laws: Laws that restrict how land is used to prevent negative externalities (e.g., keeping noisy factories away from quiet neighborhoods).

• Burden of Adjustment: Laws usually place the requirement to change on the party who can do it at the lowest cost(e.g., toxic waste is regulated most strictly on highly valued commercial waterways).

• Optimal Level \neq Zero:

The best amount of pollution is rarely zero. It is the level where the marginal cost of reducing it equals the marginal benefit of the reduction.

Tragedy of the Common

A resource that is open to everyone and owned by no one.

Private Property Rights:

A primary solution to the "Tragedy,"

Explicit Costs:

These are the actual payments a firm makes to its factors of production (e.g., wages, rent, materials).

Implicit Costs:

The opportunity costs of the resources supplied by the firm's owners. This is the income you could have earned if you used your time or money elsewhere.

Normal Profit:

This is exactly equal to the implicit costs. It is the minimum level of profit needed to keep a person in their current business.

• Economic Loss:

An economic profit that is less than zero.

Rationing Function of Price:

The process by which changes in prices distribute scarce goods to those consumers who value them most highly.

Allocative Function of Price:

The process by which changes in prices direct resources away from overcrowded markets and toward markets that are underserved.

Normal Profit:

The opportunity cost of the resources invested in a firm. When a firm earns normal profit, its economic profit is zero.

Barrier to Entry:

Any force that prevents firms from entering a new market (e.g., legal constraints like copyrights or practical constraints like product compatibility).

• First-Dollar Insurance Coverage:

Insurance that pays all expenses generated by the insured activity, leaving the user with a marginal cost of zero.

Positive Economic Profit:

attracting additional resources and new firms into a market. increases supply and drives the price down until economic profit reaches zero.

Economic Loss:

Acts as a "stick," causing resources to leave a market. This decreases supply (shifting the supply curve to the left), which raises prices until the remaining firms cover all costs.

Adverse-Selection Problem:

A situation in individual insurance markets where individuals know more about their own health status than the insurance company does

The "Death Spiral":

When only sick people buy insurance, premiums rise. These high prices drive out relatively healthy people, forcing premiums even higher, eventually making insurance unaffordable for most.

• Efficient Pollution Reduction

the cost to reduce one more unit of pollution) is the same for all polluters.

• Taxing Pollution

Instead of forcing every firm to cut by the same amount, the government sets a tax per ton of emissions. Firms that can clean up cheaply will do so to avoid the tax;

Auctioning Pollution Permits (Cap and Trade):

The government sets a target level of pollution and auctions off a limited number of permits.

In-Kind Transfers:

Payments made in the form of goods or services (like food stamps or Medicaid) rather than cash.

Means-Tested Benefit:

A program where the benefit level declines as the recipient earns additional income.- like section 8

Poverty Threshold:

The annual income level below which a family is officially classified as "poor" by the government

• Negative Income Tax ):

system where the government grants every citizen a cash payment each year, which is then financed by an additional tax on earned income.

Market Equilibrium:

A state where the price has reached the level where quantity supplied = quantity demanded.

Economic Surplus:

The total benefit gained by both buyers and sellers from participating in a market.

Price Ceiling (Price Below Equilibrium):

•

When the government sets a maximum price (e.g., $1.00 for milk hen equilibrium is $1.50).

Result: It creates excess demand (shortages).

Inefficiency:

someone is willing to pay more and someone is willing to sell for more, but the law prevents it.

Price Subsidies:

When the government pays part of the cost of a good (like gasoline).

Externalities:

These occur when the private cost or benefit of an action differs from the social cost or benefit (e.g., pollution).

• Abatement:

The process of reducing or eliminating pollution.