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invisible hand of free markets
government doesn’t need to get involved since the needs of society are met by firms seeking to make a profit
market failure
a situation in which the free-market system fails to satisfy society’s wants
when the invisible hand doesn’t work
private markets don’t efficiently bring about allocation of resources
govt may be called to satisfy society’s wants
four market failures
public goods
externalities
imperfect competition
unequal distribution of income
marginal social benefit
demand
marginal social cost
supply
socially optimal quantity
MSB = MSC
externality
third person side effect
why externalities are market failures
free market doesn’t include external costs or benefits
no govt involvement would mean too much or too little of something
negative externalities
situation that results in a cost for a different person other than the original decision maker
overallocation
negative externality deadweight loss
between MSC and S = MPC, above D = MSB
flat side facing right
positive externalities
situations that result in a benefit for someone other than the original decision maker
underallocation
positive externality deadweight loss
opposite triangle
flat side facing left
left of equilibrium
govt handles negative externalities with
per unit tax (the amount of externality)
govt handles positive externalities
subsidy to consumer or producer (per unit)
consumer → demand right
producer → supply right
tragedy of the commons
goods available to everyone are often polluted because nobody has incentive to keep them clean
no monetary incentive to use them efficiently
result is high spillover cost
perverse incentives
regulations are put in place and firms try to avoid this and has additional negative impact (ex: if this species is found, it is protected land → farmers kill the species when they find it)
public sector
part of economy primarily controlled by the govt
private sector
part of economy run by private individuals and companies that seek profit
free riders
individuals that benefit without paying
keep firms from making profits
if left to free market, essential services will be underproduced
non exclusionary
cannot exclude people from enjoying the benefits
non rivalrous (shared consumption)
one person’s consumption of a good does not reduce the usefulness to others
public goods
non exclusionary and non rivalrous
private goods
excludable and rivalrous
club goods
excludable but non rivalrous
common goods
non excludable but rivalrous
antitrust laws
laws designed to prevent monopolies and promote competition
why regulate monopolies
keep prices low
make monopolies efficient
regulate with price ceilings
not w/ taxes bc will limit supply
allocative efficiency / socially optimal price
P = MC
normal profit / fair return price / break even
P = ATC
natural monopoly
one firm can produce the socially optimal quantity at the lowest cost due to economies of scale
if govt sets price ceiling to get socially optimal quantity
firm makes a loss and requires a subsidy
why averages aren’t useful
they don’t show anything about income distribution
lorenz curve
shows the degree of income inequality
straight line is perfect equality
lorenz curve is actual distribution (bowed out to bottom right)
gini coefficient
statistical measurement of income distribution
area inside banana divided by triangle banana is in
higher number → more inequality
lower number → less inequality
welfare provides a ---- for citizens
safety net
taxes
mandatory payments made to the government to cover costs of goverment
finance govt operations
influence economic behavior of firms and individuals
progressive taxes
takes a larger percent of income from high income groups (current federal income tax system)
proportional taxes (flat rate)
takes the same percent of income from all income groups
regressive taxes
takes a larger percentage from low income groups (sales tax, consumption tax)
Note 
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