Chapters 7-9

Pareto efficiency

When no one can be made better off without making someone else worse off

Example: When price was set at $20, consumers were made better off, but producers were made worse off

Efficiently allocates goods and services to buyers and sellers, leads to efficient production within an industry, and efficiently allocates resources across industries.

The invisible hand does what

Social surplus

The sum of consumer and producer surplus

pursue their own self-interest. and it results in the most efficient (least cost) production allocation.

The invisible hand directs MANAGERS to do what

Free entry and exit

Allows reallocation of assets to their greatest valued uses, even across industries

Steps to calculate profit

1. determine optimal quantity (MR=MC)

2. determine ATC at the optimal quantity

3. compare P=MR and ATC

When P>ATC, we have economic profits

When P<ATC, we have economic losses

When P=ATC, we have breakeven

A reallocation of resources (to another market)

Economic profits in one sector combined with Economic losses in another will cause what?

The invisible hand

a metaphor created by Adam Smith to describe how self-interest benefits society and the market as a whole. the key to this is price

Deadweight Loss

The reduction in social surplus resulting from a market intervention

Equity

This addresses the issue of a “fair” distribution of resources across a society

Equity and Efficiency (Perfectly Competitive Markets are efficient)

One of the roles of government in our economy is to address efficient outcomes that we may not consider to be equitable

Production possibilities curve (PPC)

shows the relationship between the maximum production of one good for a given level of production of another good.

Comparative advantage

The ability of an individual, firm, or country to produce a certain good at a lower opportunity cost than other producers.

Absolute advantage

The ability of an individual, firm, or country to produce more of a certain good than other competing producers, given the same amount of resources

Terms of trade

The negotiated exchange rate of goods for goods

export

any good that is produced domestically but sold abroad.

import

Any good that is produced abroad but sold domestically.

Net importer

A country which imports are worth more than exports over a given time period.

Free trade

The ability to trade without government hindrance or encouragement

World price

The prevailing price of an item on the world market

Globalization

The shift toward more open, integrated economies that participate in foreign trade and investment.

Protectionism

The idea that free trade can be harmful, and government intervention is necessary to control trade.

tariffs

taxes that are levied on goods and services transported across political boundaries

North American Free Trade Agreement (NAFTA)

an agreement signed by Canada, Mexico, and the United States to create a trilateral trade bloc and reduce trade barriers among the three countries.

Externality

This occurs when economic activity has either a spillover cost or a spillover benefit on a bystander

Pecuniary externality

This occurs when a market transaction affects other people only through market prices.

Internalizing the externality

When agents account for the full costs and benefits of their actions, they are doing this.

Property right

This gives someone ownership of a property or resources.

Coase Theorem

States that private bargaining will result in an efficient allocation of resources.

Transaction costs

The costs of making an economic exchange

Command-and-control regulation

This either directly restricts the level of production or mandates the use of certain technologies.

Market-based regulatory approach

This internalizes externalities by harnessing the power of market forces.

Pigouvian tax

Also known as a corrective tax, this is a tax designed to induce agents who produce negative externalities to reduce quantity toward the socially optimal level.

Non-excludable good

Once this is produced, it is not possible to exclude people from using the good.

Non-rival good

This is a good whose consumption by one person does not prevent consumption by others.

Public goods

This is a good that is both non-rival and non-excludable.

Private good

This is a good that is rival and excludable.

Club good

This is a good that is non-rival but excludable.

Common pool resource goods

There are goods that are rival and non-excludable.

Free-rider problem

This occurs when an individual who has no incentive to pay for a good does not pay for that good because nonpayment does not prevent consumption.

Private provision of public goods

This takes place when private citizens make contributions to the production or maintenance of a public good.

Tragedy of the commons

This results when common pool resources are dramatically overused.