AP Microeconomics Unit 6 Notes

Externalities : external costs and benefits for people not related to initial decision

Positive Externalities : when society benefits

Negative Externalities : when society has losses

Market Failure : occurs when the outcome in a market is inefficient

• externalities lead to inefficient market outcomes

Marginal Social Cost (MSC) : of something is the additional cost imposed on society as a whole by one additional unit

Marginal Social Benefit (MSB) : of something is the additional benefit to society as whole from one additional unit

What leads to market failure ?

• Market Powers : Monopoly, Oligopoly, Monopolistic Competition
• Asymmetric Information : lack of information provided by buyers or sellers
• Private Costs / Benefits Only : Negative and Positive externalities in Production and Consumption
• Insufficient Production of Public Goods : Goods and services provided by the government

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Important Notes :

• The market equilibrium quantity is equal to the social optimal quantity only when all social benefits and costs are internalized in the market
• Total Economic Surplus is maximized when MSB + MSC
• The government is needed to reduce some market inefficiencies

Producing one more unit of any good that has a positive externality yields two kinds of benefits :

• The marginal private benefits of a good is the marginal benefit that accrues to consumers of a good, not including any external benefits
• The marginal external benefit of a good is the addition to external benefits created by one more unit of the good

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Adding both yields the total marginal social benefit :

MSB = MPB + MEB

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If you get a flu shot, you capture a private benefit : you are less likely to to get sick

Your flu shot also provides a positive externality : anyone you would otherwise inflect is also less likely to get sick

Because this social benefit is not captured privately the market tends to produce less an optimal of flu shots

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MPB = positive externality.marginal private benefit

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MSB > MPB , government provides subsidies that equal to the benefit

To produce a unit of livestock, owners pay a private cost : the food and facilities required to produce the unit

There is also a negative externality : the waste and methane that escapes into the environment isn’t paid by the owner.

Because this special cost is not capital private, the market tends to produce more than the optimal quantity of livestock

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MC = D = allocative inefficiency

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Excludable : not everyone has access unless you pay

Rival in consumption : can’t be consumed @ same time

Private good : both excludable and a rival in consumption

Public good : non excludable and non rivalrous in consumption  , leads to positive externalities

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 Free-rider problem : impossible to make everyone pay, positive externalities

• like private goods, public goods should be produced until MSC=MSB

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Why does the government have antitrust laws ? To prevent firms from acting like monopolies, and to prevent collusion

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Natural Monopoly - usually come from high fixed costs

• Have downward sloping ATC through the demand curve

Produce at MR=MC up to demand

Government can regulate by making them produce at MC=D, or D=ATC

If D = ATC, zero profit

If D=MC, earn a loss so the government will provide a subsidy

D=MC = allocatively efficient point

Price floors - binding when prices are above the equilibrium price. it is the new minimum price you are allowed to charge

• causes a surplus
• above equilibrium on graph

Price ceilings - binding when prices are below the equilibrium price. It is the new maximum that you are allowed to charge

• causes a shortage
• below equilibrium on graph

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Produce at the socially optimal level which is allocatively efficient.

D=MC

Then add a subsidy so that they do not go out of business

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consequences of poverty

1. lack of healthcare (good health care)
2. lack of affordable housing
3. cycle of poverty : children in poverty often can’t escape it in adulthood

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mean household income : the average income across all households

median household income : the income of the household lying in the middle of the income distribution

Gini coefficient : summarized income inequality based on how unequally income is distributed

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Why is there income inequality?

• supply and demand in labor markets
• mrp of the worker
• human capital
• social capital/mobility
• inheritance
• access to financial markets
• discrimination
• bargaining power

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Policies to address inequality

• Taxes and transfers
• Minimum wage laws
• Anti-poverty programs
• Income protection programs

Can also provide scholarships, training and other laws that will impact the labor market supply and demand

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Taxes can be :

• Proportional - each person pays the same percentage of their income : no impact on income distribution
• Progressive - taxes are higher % on people earning a higher income : reduce income inequality, marginal tax rates that increase as income increases
• Regressing - taxes are lower % on people earning higher income : increases income inequality

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Transfers can lead to income equality

Minimum wage can lead to income equality

Anti Poverty programs - Non means tested (everyone gets it)

• SS, medicare, unemployment insurance, workers comp

Anti Poverty programs - means tested

• Medicaid, housing subs, earned income tax credit

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negative externality : msc > mpc

msc - mpc = mec