micro CRAM unit 6

market failure

a situation in which the free-market system fails to satisfy society’s wants

private markets

do not efficiently bring about the allocation of resources

4 market failures

1. public goods

2. externalities (third person side effects)

3. imperfect comp. (monopolies)

4. unequal distribution of income

the demand is the ________ of the good and its usefulness to society.

Marginal Social Benefit

the supply is the __________ of providing each additional quantity.

Marginal Social Cost

Socially optimal quantity

MSB=MSC

externalities

3rd person side effect

• there are external BENEFITS or external COSTS to someone other than the O.G. decision maker.

externalities are market failures because…

the free market fails to include external costs or external benefits

w/ no gov’t involvement there would be too much of some goods, and too little of others for example…

• smoking cigarettes (free market assumes cost of smoking is fully paid by smokers

• gov’t recognizing external costs and makes policies to limit smoking

negative externalities

when someone uses a product that decreases the benefit of others

• ex: smoking

• MSC > MPC (correct w/ per unit tax)

positive externalities

when one uses a product, others benefit

• (ex: education)

• MSC < MPC (correct w/ subsidy)

public goods

goods that are non-excludable (no one can be prevented from using them) and non- rivalrous (one persons use doesn’t reduce availability for others)

• ex: public parks, street lights, law enforcement

public goods are a market failure b/c…

in a free-market system, firms seek to earn profit but due to the nature of the non excludable public goods, providers have little incentive to produce them

public sector

the government; uses tax revenue to help with the market failure of public goods to provide society with its needs

free-rider problem

an individual who benefits from using a public good w/o paying for it

• ex: one person pays for streetlight which benefits whole neighborhood.

rivalrous

if someone consumes a product, others cannot

• ex: food, shoes etc

• non rivoulrous: national defense, fireworks

• somewhere in middle: schools and roads

excludable goods

non payers can be prevented from enjoying the benefits

• ex: food, school, etc

government will provide _______ to producers.

subsidies

• subsidies - financial assistance from the government

private goods

both EXCLUDABLE and RIVAL

tragedy of the commons

happens when people overuse a commons good b/c they act in their own self-interest

• they want to take as much as they can before it runs own

• ex: overfishing/deforestation

low congestion goods (club goods)

EXCLUDABLE but NON RIVAL

ex: cable TV/ streaming services

antitrust law

designed to prevent monopolies and promote competition

why are monopolies a market failure?

because they destroy competition

causes of inefficient markets:

• market power

• externalities

• non rival and non excludable goods (public goods)

forms of gov’t intervention:

• taxes

• subsidies

• price floors/ceilings

• regulation

per unit subsidy

gives benefit per unit

• perfect competition: MC, ATC, AVC decreases, price doesn’t change (price taker)

• monopolistic competition: MC, ATC, price decreases (price maker at MR=MC)

lump sum subsidy

gives benefit no matter how many units

taxes will always shift supply curve to the ______ in the long run; _______.

left; profits decrease

per unit tax

increase in MC, ATC, and AVC

• perfect competition: MC, ATC, AVC increases, price doesn't change (price takers)

• monopolistic competition: MC, ATC, price increases (Price maker at MR=MC)

lump sum tax

only increases ATC

• won’t change output level

non price regulation

works like taxes, they ensure competition/environmental protection/ health and safety

antitrust policy

lawsuits, price controls, subsidies

price ceiling

• sets minimum price

  • perfect comp: causes shortage

  • mono comp: becomes MR curve; price and output decreases

price floor

• sets maximum price

  • perfect comp: leads to surplus

  • monopsony: wages go up, and workers go up

the Lorenz curve

measures the distribution of income inequality (you want to be as closest to line of equality as possible)

income

wages, rent, interest profit

income distribution

measures % of income that goes to individuals in different percentiles/brackets

• in a system where perfect equality, everyone would receive equal shares of income

gini coefficient

statistical measurement of income distribution (area A/area A+B)

• closer to 0 = more equal

• closer to 1 = more inequal

where does inequality come from?

• human capital (knowledge + talent)

• social capital (connections + relationships)

• inheritance

• discrimination

• access to financial markets

• mobility & opportunity

• bargaining power (firms, unions)

progressive taxes

takes larger % of income from high income groups (takes more from rich people)

• ex: current federal income tax system

proportional taxes

(flat rate) takes the same percent of income from all income groups.

• ex: 20% flat income tax on all income groups

regressive taxes

takes larger % from low income groups (takes more from poor people)

• ex: sales tax

policies to address inequality:

• scholarships

• taxes

• min. wage laws

• anti-poverty program

• income protection program