ECON Study Guide 7 & 8

Externalities 1

1) one type of market failure, it occurs when there is an inefficient allocation of resources

Externalities 2

2) costs or benefits of a market activity impacts a third party

Externalities 3

3) market equilibrium is not efficient

Externalities 4

4) government can sometimes improve market outcomes

Internal Costs

costs of a market activity paid only by an individual

External Costs

costs of an activity period imposed on the people not participating in that market

Social Benefits

Internal Costs + External Costs =

Negative Externalities

over-provided the good from society’s perspective

Negative Externalities

“too much” of the good is produced and consumers

Negative Externalities

external costs experienced by third parties

Ex: pollution, cigarette, smoke, and loud music

Negative Externalities

market quantity is too high meaning you want less of a good

Positive Externalities

under-provides the good from society’s perspective

Positive Externalities

“not enough” of the good is produced and consumed

Positive Externalities

external benefits experienced by third parties

Ex: vaccines/hand washing, lawn care, decorations around holidays, and education

Positive Externalities

market quantity is too low meaning you prefer more

Property Rights

give the owner the ability to exercise control over a resource, which creates incentives to maintain, protect/conserve, and trade with others

Case Theorem

no barriers to negotiate, property rights are clearly defined then private parties can bargain to correct externalities and reach the socially efficient outcome

Excludable Good

possible to prevent people who have not paid for it from having access to it

Rival Good

good cannot be enjoyed by more than one person at a time

Private Goods

• Rival + Excludable

• you pay and consume it yourself

Ex: food, clothes, and shoes

Public Goods

• Non-Rival + Non-Excludable

• difficult to exclude non-payers from consumption, which leads to the Free-Rider Problem

ex: public schools and military defense

Club Goods

• Non-Rival + Excludable

• many can use, but you must pay

Ex: subscriptions

Common Resource Goods

• Rival + Non-Excludable

• Tragedy of the Commons

Ex: overfishing and hunting

Free-Rider Problem

someone can receive a benefit of the good without paying for it

Tragedy of the Commons

occurs when a good becomes depleted or ruined because everyone has access, but usage reduces supply

Rival + Excludable

private goods

Non-Rival + Excludable

club goods

Rival + Non-Excludable

common resource goods

Non-Rival + Non-Excludable

public goods

Private markets fail because…

• fail to supply public goods due to the Free-Rider Problem

• fail to efficiently allocate common resources due to the Tragedy of the Commons

• property rights are unclear or unenforceable

Common Resource Goods

tragedy of the commons

Public Goods

free-rider problem

Profits

money a firm has left after paying all its costs

Profit = ( P x Q ) - TC

How to calculate profits

Total Revenue > Total Cost

Profit = ( P x Q ) - TC

Costs

explicit and implicit

Explicit Costs

tangible, out-of-pocket expenses (money actually changes in hands)

Examples of Explicit Costs

wages, raw materials (coffee beans, seasonings, ingredients), utilities, and advertising

Implicit Costs

• opportunity costs of doing business, owner’s time, and capital

• difficult to quantify, non-monetary

Accounting Profit

total revenue - explicit costs

Economic Profit

total revenue - implicit costs/explicit costs

Due to ignoring the implicit costs

accounting profit will be larger than the economic profit

Production Function

describes the relationship between the inputs a firm uses and the output it creates

Inputs

resources used to create goods and services

Marginal Product

• change in output associated with one additional unit of input

• division or labor, involves breaking up tasks and assigning these tasks to individuals

Diminishing Marginal Product

when successive increases in inputs are associated with a slower rise in output

Variable Costs

TVC / costs that change with the rate of output

Ex: labor, utilities, raw materials

Fixed Costs

TFC / costs that do not vary with output (aka Overhead)

Ex: rent, insurance, property taxes

Total Cost

TVC + TFC

AVC

Average Variable Cost = TC / Q

AFC

Average Fixed Cost = TCF / Q

Marginal Cost

• increase in cost from producing one more unit of output

• change in total cost divided by change in output

• = TC / Q

Economies of Scale

ATC falls when production expands

Constant Returns to Scale

ATC doesn’t change when production expands

Diseconomies of Scale

ATC rises when production expands

Short Run

period during which some inputs in the production process are fixed

Long Run

period during which all inputs in the production process can be varied