week 3: markets and externalities

socially efficient point

MC = MWTP

net value equation

net value = total willingness to pay - total costs

market

decentralized collection of buyers and sellers whose interactions determine the allocation of a good or set of goods through exchange

how do market systems work?

allowing buyers and sellers to seek out exchanges

first theorem of welfare economics

if all goods are traded in competitive markets at publicly known prices, and all individuals maximize their own utility, and there are no externalities or public goods, then any market outcome is efficient

if the point on the graph where supply and demand intersect has prices above:

too much supply, competition among sellers will bid prices down

if the point on the graph where supply and demand intersect has prices below:

too much demand, competition among buyers will bid prices up

list the assumptions of the first theorem in a way that the market could fail:

1. competitive firms, utility-maximizing consumers

2. publicly known prices

3. no externalities or public goods

monopoly

a firm who is the only supplier in a market; tend to undersupply goods to keep prices high

monopsony

individual/firm who is the only consumer in the market

externalities

an externality results when the actions of one individual (or firm) have direct, unintentional, and uncompensated effect on the well-being of others

private costs

when deciding how much to produce, profit maximizing firms normally take into account direct costs to create a good/service

external costs

costs are external to the producer but internal to society as a whole

social costs

social costs = private costs + external costs

pecuniary externalities

operate through price effects; the increase in price paid by consumers is compensated by the increase in price received by the producer; no DWL is created (no market failure exists)

private benefits

benefits realized by the party paying for the good or service

external benefits

benefit that accrues to somebody who is outside (external to) the decision about consuming or producing the food or resource that causes externality

social benefits

private benefits + external benefits

public goods

if a good is made available to one person, it automatically becomes available to others

free rider

person who underpays relative to the benefits they receive

nonrival

my consumption does not reduce amount you get to comsume

ex. cable tv, scientific knowledge

nonexcludable

i can’t prevent you from consuming a nonexcludable good

ex. fish in a small pond with no fences, scientific knowledge

pure private

excludable and rival

club goods

nonrival and excludable

open access

rival and nonexcludable

pure public

high non rival and non exclusive

aggregate demand

sum vertically; hold Q constant and add up total MWTP

what are examples of how multiple market failures could influence market outcomes?

a product that creates both positive and negatice externalities

a monopolist selling a good that negatively impacts the environment

monopolists and price setters arise when:

1. control over critical input

2. technological innovations (with patent protection)

3. government regulations

marginal revenue curve (MR)

downward sloping curve for monopolists; every additional unit they sell reduces price for all units; monopolists sell just enough to let MC = MR

markup

difference between price and MC

monopoly producer + negative externality:

failures offset each other; decreases DWL

monopoly producer + positive externality:

failures augment each other; increases DWL

tragedy of the commons

incentive of private ownership to maintain resource; if there is public/multiple ownership then it is more difficult to regulate resource usage

open-access / common pool resource

a facility or resource that is open to uncontrolled access by individuals who wish to use it; non-excludable but rival

common property

excludable for individuals outside the group