Microeconomics-Creative Destruction, Market Failures, Institutions, Organizations, and Government

Economic profits

additional payment above and beyond the compensation that can be earned in the next best alternative activity

Entrepreneurs

individuals who take on the risk of attempting to create new products or services, establish new markets, or develop new methods of production

Rewards of entrepreneurship

economic profits that can be earned by being the first to market with a new product

Innovation

helps to create barriers to entry that reward the innovator, breaks down existing market imperfections by encouraging efforts to invent around existing barriers to entry

Creative Destruction

the impact of entrepreneurs; development of new and improved products causes long-run improvements in well-being

Market failures

circumstances in which competitive markets fail to produce socially desirable outcomes

Externality

arises when the actions of one person affect the well-being of someone else but neither party pays or is paid for these effects

Positive externality

externality that has a beneficial effect

Negative externality

externality that has a harmful effect

True social cost

combination of firm’s marginal cost and the cost/profit from an externality

Optimal level of a negative externality

not zero because the activity that generates the externality has a certain positive value

Coase Theorem

as long as the parties involved can negotiate with each other, the private market should be able to resolve the inefficiencies created by externalities

Caveats to the Coase Theorem

theorem does not hold up when property rights are poorly defined and the costs of negotiating are too high

Government regulation of externalities

taxes, subsidies, pollution credits

Tragedy of the commons

when a resource is owned jointly, no one takes account of the negative externalities caused by overuse

Rivalry in consumption

characteristic of a good in which one person’s consumption reduces the amount that is available for others

Excludability

ability to control who consumes a good

Private goods

goods with a high degree of rivalry and a high degree of excludability

Common resources

goods with a high degree of rivalry and a low degree of excludability; suffers from the tragedy of the commons, source of externalities

Collective goods

goods with a low degree of rivalry but a high degree of excludability; easily privatized, often leads to natural monopolies

Public goods

goods with a low degree of rivalry and a low degree of excludability; difficult to privatize, has a marginal cost of close to zero; often provided by the government

Institutions

formal and informal rules that structure human interaction

Organizations

help to organize human interaction through formal rules and structures

Limitations of institutions and organizations

need for voluntary cooperation

Powers of government

ability to tax citizens, legal monopoly on the legitimate use of force, can enforce contractual obligations

Pork barrel politics

proclivity of elected officials to introduce projects that steer money to their communities

Logrolling

vote trading; politicians support their colleagues projects so that they can win support for their own projects

Rent seeking

socially unproductive activities that seek simply to direct economic benefits to one set of actors rather than another; ex. bribery