Microeconomics: Market Evaluation and Policy

This set covers the coordination of labor, pure economic systems (traditional, command, market), Pareto efficiency, consumer and producer surplus, and various market and government failures.

Traditional system

An organizational form dominated by social norms and informal rules where economic activities and vocational choices are determined by history and culture.

Command system

An economic system where a central government decides what, how, and how much is produced, and who consumes the goods and services.

Market system

An economic organizational form based on voluntary exchange where individual companies and households make decentralized decisions based on self-interest.

Invisible hand

Adam Smith's concept describing how a decentralized price system coordinates the decisions of consumers and producers without the need for a central authority.

Mixed economies

Economic systems that simultaneously contain elements of the three pure types: traditional systems, command systems, and market systems.

Pareto improvement

An economic change that increases the welfare of at least one individual without decreasing the welfare of at least one other individual.

Pareto efficiency

A situation where it is impossible to implement a Pareto improvement, meaning resources are not being wasted.

Pareto frontier

A curve showing the maximum welfare one individual can acquire when the welfare of all other individuals is fixed, given preferences, production factors, and technology.

First fundamental theorem of welfare economics

The theory stating that if price formation is left free in an ideal market under perfect competition, the equilibrium leads to a Pareto efficient situation.

Consumer surplus

The difference between what a consumer is willing to pay ($WTP$) and what they actually pay ($p$) at the market price.

Consumer sovereignty

The principle that the consumer knows best what is good for them and can perfectly estimate their own willingness to pay.

Producer surplus

The difference between what a producer actually receives ($p$) and the minimum price they were willing to receive based on their marginal cost ($MC$) curve.

Total welfare

The sum of consumer surplus ($CS$) and producer surplus ($PS$), calculated as current total willingness to pay minus total production cost ($WTP - TC$).

Deadweight loss

The welfare loss (also called excess burden) resulting from any deviation from the market equilibrium where marginal social benefit equals marginal social cost.

Equity

The fair distribution of wealth or prosperity in a society, which is not automatically guaranteed by market forces.

Imperfect competition

A market failure where market power exists on the supply side (monopoly) or demand side (monopsony), causing departures from ideal price formation.

Public goods

Goods consumed by several consumers at once where the marginal social benefit is greater than individual willingness to pay ($MSBij > MWTPij$), often leading to underproduction.

Externalities

Market failures occurring when consumers or producers do not consider the effects of their decisions on other economic agents, leading to gaps between marginal costs and marginal social costs.

Internalities

An external effect of an individual's current self on their future self due to limitations in rationality, such as smoking.

Asymmetric information

A market failure where one party in a transaction is better informed than the other, which can lead to the disappearance of the market.

Government failure

A situation where government intervention fails to serve the common good because political actors pursue their own self-interest within the constraints of their environment.

Property rights

The legal foundation of a market system ensuring that ownership is well-defined and respected, which requires a functioning legal system.