market basics & market failures

consumer surplus

consumers gaining from paying less than their WTP to buy goods

producer surplus

producers gaining from selling their goods higher than their minimum WTS

horizontal sum

private goods; summing the quantities at a given price to determine total market demand

vertical sum

public goods; summing people’s WTP (price) of a given quantity to determine total market demand

market failure

when free markets fail to allocate resources efficiently (ie. welfare loss)

perfect markets need…

• perfect competition & full info

• no externalities, rational actors

private marginal cost (PMC)

the market’s MC of producing that unit of good

social marginal cost (SMC)

PMC plus any other costs associated with the production of that good that are imposed on others (aka. any “by products”)

• negative externalities: SMC - PMC + marginal damage

• positive externalities: SMC > PMC

negative externality market result & welfare effects:

Q the market produces > socially optimal Q; overproduction, DWL

positive externality market result & welfare effects:

Q the market produces < social optimal Q; underproduction, DWL