U6 Cram

M74-75

Free Market Characteristics

  • Little government involvement in the economy. (Laissez Faire = Let it be)

    • Individuals OWN resources and determine what to produce, how to produce, and who gets it.

    • The opportunity to make PROFIT gives people INCENTIVE to produce quality items efficiently.

    • Wide variety of goods available to consumers.

    • Competition and Self-Interest work together to regulate the economy.

    Market Failure

  • Market Failure

    • a situation in which the free-market system fails to satisfy society’s wants

      • private markets do not efficiently bring about the allocation of resources → government must step in to satisfy society’s wants

Terms to Know

  • MPC is Marginal Private Cost: the marginal cost of producing the good, not including any external costs


  • MEC is Marginal External COST : the increase in external costs to society by one additional unit. These costs are not yet included in MPC.


  • MSC is Marginal SOCIAL COST : the additional cost imposed on society as a whole by one additional unit. (MPC + MEC)


  • MPB is Marginal Private Benefit: the marginal benefit that accrues to consumers of the good, not including external benefits. MPB is equal to the price a consumer pays for a good or service.


  • MEB is Marginal External Benefit: the additional external gain to society as a whole from an additional unit. This is NOT yet included in MPB.


  • MSB is Marginal SOCIAL Benefit: the additional gain to society as a whole from an additional unit.

Formulas

  • MSB = MPB + MEB

  • MSC = MPC + MEC

Four Market Failures

  • Public Goods

  • Externalities

  • Monopolies

  • Unfair distribution of income

FMF (Externalities)

  • Goal is to produce @ MSC = MSB

  • when they are not equal there is an externality

  • MSC = supply

  • MSB = demand

  • externalities are third-person side effects (benefits or external costs to someone other than the original decision maker)

Negative externalities

  • situation that results in a COST for a different person than the original manufacturer

    • ex. pollution while producing a good

      • government will recognize the cost and limit production as a result

    shaded triangle is representative of deadweight loss

  • What should the government do to fix a negative externality, PER UNIT TAX

Coase Theorem

Positive Externalities

  • situations that result in a BENEFIT for someone other than the original manufacturer

    • ex. flu vaccines, education, home renovation

  • same logic except opposite to negative externality

    • to fix positive externality government should do a per unit subsidy

      • incentivizes firms to produce more or consumers to purchase more, shifting demand curve up/right

Perverse Incentives

  • unintended consequence of an action that leads individuals or organizations to act against the desired outcome

m75 FRQ PRACTICE

M76

Public vs Private

  • 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

Goods

  • Goods have 2 characteristics that are required for it to be provided in efficient quantities by a market economy

    1. They are excludable (suppliers of the good can prevent people who don’t pay from consuming it)

    2. They are rival in consumption (same unit of the good cannot be consumed by more than one person at the same time)

  • 4 Types of Goods

    • Private: Rival in consumption, excludable

    • Artifically Scarce: Nonrival in consumption, excludable

    • Common resources: Rival in consumption, non-excludable

    • Public goods: Nonrival in consumption, non-excludable

Free Riders

  • Free Riders

    • individuals that benefit without paying

    • keep firms from making profits

      • if left to free market, essential services would be under produced

    • government can find new ways to punish free-riders or use taxes to provide service to everyone