AP Micro unit 6

Market failure

occurs when a market creates an inefficient outcome

Market Failure

Sources and How

1. Monopolies → underproduction of Q

2. Positive externalities → underproduction of Q

3. Negative externalities → overproduction of Q

4. Asymmetric Information → lack of info by seller or buyer

Socially optimal

Marginal Social Benefit = Marginal Social Cost → MSB = MSC

“efficient/allocative” means this

Marginal Analysis

Society should act when

MSB > MSC

Competitive Market without externalities

MSC = S

MSB = D

no private curves found

Pe/Qe is where we produce → b4 n after leads to over/underproduction

Firms’ socially optimal

Perfectly competitive: P = MC

below or over price resaults in higher or lower Q produced

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Monopoly: P = MC vs. profit at MR = MC

MC curve is the MPC curve

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Monopsony: S= MRP vs. hire at MRP = MFC

At Socially optimal points:

1. TSurplus is maximized

2. No DWL

3. resources are allocated optimally

“When costs and benefits are internalized”

producing at the social optimal Q

All things that cause DWL

1. Taxes + trade

2. price floor/ceiling

3. imperfect comp.

4. externalities

5. public goods → cant charge ppl

6. asymmetric info

Externalities

Determining a tax or subsidy effect

1. is the market structure over or under producing?

2. Tax will reduce DWL if overproduction

3. Subsidy will reduce if underproduction

4. OR: DWL will worsen if given tax when under and vice versa

→ is isnt about the externality type

Negative externalities

Definition

“Spill over costs” → bad effect to society

Positive Externalities

“Spill over benefits” → good effect to society

Externalities in consumption/Production

Consumption: When externalities happen due to consumers = Effects demand curve

Production: externalities happen due to Producers = Effects supply curve

Negative externalities of Production

Graph

MPC = MSB is where we produce equilibrium

Qo: optimal Q

DWL always points to optimal Q point

MPC is above MSB

Negative externality of Consumption

produce at MPB = MSC → equilibrium pe qe

Production occurs at equilbrium

MPB is below Demand

What shifts in positive externalities

Production: MPC above MSC

Consumption: MPB above MSB

→ DWL points to optimal point

Negative externality

Per- unit Tax

→ regardless of consum/prod

The negative externality is a overproducing market in which will become socially optimal with a tax that shifts focus on curve MPC to MSC → production becomes at Qo

• tax starts from Po till we hit the MPS curve

Positive externality

Per- unit subsidy

→ regardless of consum/prod

The positive externality is a underproducing market in which will become socially optimal with a tax that shifts focus on curve MPB to MSB → production becomes at Qo

• subsidy starts from optimal point till we hit the MPB curve

“Market Quantity”

Q equilibruim not optimal Q

Monopoly producing a non-rival good

Qs n Ps = p=mc → optimal

Qu is production occurs

Red is DWL

MC WILL EQUAL ZERO

Excludable

paid for/[ban-able by gov]

people can be prevented from using it if they don’t pay

Non-excludable

Free by government

Rival

Diminshes for others with personal use

Non-rival

No amount of using it will diminish its use

What effect does a non-excludable good have on a market

Demand < MSB

“Perfectly competitive free market economy”

unit 6.5 reference → elaborate later