unit 6

Msc-marginal social cost

Msb-marginal social benefits

msc=msb  (socially optimal quantity)

Mb-slope downward

Mc-slope upward

msc=supply

msb=demand

Msb is associated with demand: bc who receives the positive impact of teh production is society in general

Msc is associated with demand: 

Find the market: add 

=society’s demand(msb)

msc=cost, how much it costs to produce

msb<msc-society wants less

And the opposite

Externalities

-it is a third-person side effect(next to the company)

-there are external benefits or costs to someone other than the original decision maker

Why are externalities market failures?

-the free market fails to include external costs or external benefits

-With no government involvement there would be too much of some goods and too little of others.

Negative externalities

Situation that results in a COST for a different person other than the original decision maker.

The costs “spillover” to other people or society.

The marginal private cost doesn’t include the costs to society.

= Supply = Marginal Private Cost (Company’s Cost)(this equals to msc)

mpb=msb

By inc. we are going to move the graph of mpc=s=msc and masc=d=mpb : UP.

Msc will be above the mpc and same for mpb and msb

Deadweight loss-over allocation or under allocation

Per-unit tax=no deadweight loss?

Positive externalities

Situations that result in a BENEFIT for someone other than the original decision maker.

The benefits “spillover” to other people or society.

Social benefit or cost is always above

Economics of Pollution

• Goods that are available to everyone (air, oceans, lakes, public bathrooms) are often polluted since no one has the incentive to keep them clean. 

• There is no monetary incentive to use them efficiently.

• Result is high spillover costs.

SLIDES 43, 44, 45

How to distinguish Positive or Negative Externalities of Consumption and Externalities of Production - IMP. RULES

RULE #1

• PRODUCTION EXTERNALITY - always has 2 Cost Curves

• CONSUMPTION EXTERNALITY - always has 2 Benefit Curves

RULE #2(LOOK AT QUANTITIES)

• NEGATIVE EXTERNALITY - always produces too much (the Q. of the Free Market is MORE than Socially Optimal Q) - we are producing too much

• POSITIVE EXTERNALITY - always produces too little (the Q. of the Free Market is LESS than Socially Optimal Q) - we are not producing enough

RULE #3(DEADWEIGHT LOSS)

• HOW TO FIGURE OUT DWL?

 - always points to Socially Optimal

- Put a DOT on where MSB hits the MSC

- For POSITIVE Externalities the DWL always points to the right

- For NEGATIVE Externalities the DWL always points to the left

—

Public goods

Public Sector- The part of the economy that is primarily controlled by the government

Private Sector- The part of the economy that  is run by private individuals and companies that seek profit. 

Lead to market failure:

1)free rider problem

2)trategy of the commons

Why must the government provide public goods and services?

• It is impractical for the free-market to provide these goods because there is little opportunity to earn profit - this is due to the Free-Rider Problem   (Free Riders are individuals that benefit without paying)

What's wrong with free riders?

• Free-Riders keep firms from making profits.

• If left to the free market, essential services would be under produced.

To solve the problem, the government can: 

1. Find new ways to punish free-riders.

2. Use tax dollars to provide the service to everyone.

For monopoly, government will never impose taxes on monopoly or monopsony  if it is ineffective. Instead there will be a price control

Specific reasons why monopolies are bad

1)deadweight loss 

2)they are not efficient

Allocatively-producing enough quantity

Productively-at the level that resources are not wasted

3)price makers; they have market power

slide 11

• Monopolies destroy the key ingredient of the free market system- Competition.

• Price Makers

• Inefficient (productively and allocatively)

• To fix this MARKET FAILURE the government must get involved.

Why would the government regulate a monopoly? 

1. To keep prices low 

2. To make monopolies efficient

How do they regulate?

• Use Price controls: Price Ceilings NOT Taxes

Why don’t taxes work?

• Taxes limit supply and that’s the problem

Where should the government place the price ceiling?  

1.Socially Optimal Price

P = MC=D (Allocative Efficiency)

OR 

2. Fair-Return Price (Break–Even)

P = D = ATC (Normal Profit)

Price at ATC- + subsidy

THE LORENZ CURVE

Developed by American economist Max Lorenz in 1905

• Developed by American economist Max Lorenz in 1905

• Is a graphical representation of Income Distribution

• It shows income inequality or wealth inequality - how “unequal” that distribution is

• The Lorenz Curve can be contrasted with the line of perfect equality to show the scale of income and wealth inequality in a country.

Slide 33

DO NOT NEED TO DRAW IT

Social-external

private-internal