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Microecon, Chapter 7( week 7)

by: Daria Trikolenko

Microecon, Chapter 7( week 7) ECON 2106

Marketplace > Georgia State University > Economcs > ECON 2106 > Microecon Chapter 7 week 7
Daria Trikolenko

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Notes from Chapter 7
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This 4 page Class Notes was uploaded by Daria Trikolenko on Sunday October 9, 2016. The Class Notes belongs to ECON 2106 at Georgia State University taught by in Summer 2015. Since its upload, it has received 12 views. For similar materials see PRINCIPLES OF MICROECONOMICS in Economcs at Georgia State University.


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Date Created: 10/09/16
Chapter 7. Market efficiencies Externalities, or costs and benefits of market activity, that affect a third party, often lead to undesirable consequences. Internal costs of participation – the costs that only the individual participants pay. Ex. Amount person pay for gasoline for his car. External costs – costs imposed on people who are not participants in that market. Ex. Air pollution Social costs- a combination of the internal costs and the external costs of a market activity, together help a market to work efficiently. A third-party problem An externality exists whenever a private cost diverges from a social cost. A third- party problem occurs when those, not directly involved in market activity, experience negative or positive externalities. If a third party is advisedly affected, the externality is negative (ex. Second-hand smoking) Society would benefit if all consumers and producers considered both the internal and external costs of their action. Positive externalities exist when knowledgeable workforce benefits employers looking for qualified employees. Connecting for negative externalities. Complex processes in business generates many negative externalities, including the release of pollutants into the air and the dumping of waste by products. Social optimum- the price and quantity combination that would exist if there were no externalities. When negative externalities occur, the government may require externality-causing market participants to pay for the cost of their actions. Three potential solutions: 1) Install pollution abatement equipment or to change production techniques; 2) Tax can be levied as a disincentive to produce; 3) Pay for environmental damage it causes. Internalize the externality- firm must take into account the external costs to society that occur as a result of its action. This solution will shift the supply curve and will consist of combination of internal and external costs, willingness to sell good declines, or shift to the left (social optimum at lower quantity, than at the market equilibrium quantity demanded) Market equilibrium creates deadweight loss (DWL) Connection for positive externalities Vaccinated individual creates an internal benefit. External benefit is that other people will not catch the flu and contagious, which helps to protect those who don’t get flu shots. Public health officials need to encourage people to consider the external benefit of their vaccination and produces positive benefits by internalizing the externalities. To promote social optimum by encouraging economic activity that helps third parties (subsidy, price break). Subsidy acts as a consumption incentive: enables the consumer to spend less money (shifting demand curve). Subsidy encourages consumer to interline the externalities. Move form equilibrium quantity demanded to social optimum. - Helps individual realize external benefits; - Finance/ subsidize production and consumption of the good; - Low requiring consumption vaccines. Private markets are not efficient, when positive externalities, because it’s not fully capturing benefits. What are private goods and public goods? Property rights – give the owner the ability to exercise control over a resource. Private property- provides an exclusive right of ownership that allows for the use, exchange. 1) Incentive to maintain property 2) Incentive to protect (ex. Protect from theft, damage) 3) Incentive to conserve property (ex. extend the usable life of car) 4) Incentive to trade with others The Coase Theorem Whenever the externality is large enough to justify the expense, the externality gets internalized. The Theorem states that if there are no barriers the negotiations, and if property rights are fully specified, interested parties will bargain privately to correct any externalities. Private and public goods An excludable good-one that the consumer is required to purchase before being able to use it. A rival good – one that cannot be enjoyable by more than one person at a time. Private good – both excludable and rival in consumption. Since the producer gets to charge a price and the consumer gets to acquire a rival good, the stage is set for mutual gains from trade. Public good- can be jointly consumed by more than person and it’s difficult to excludable nonpayers. Since consumer can’t be easily forced to pay, they may desire of good than is typically supplied. Public goods are often under produced because people can get them without paying. Free-rider problem – occurs whenever people receive a benefit they don’t need to pay for. Ex. Street musicians Tax revenue- eliminates the free-rider problem in the context of national defense. Ex. Taxes to pay for aircraft carriers. Club goods and common-resource goods. Club goods- non-rival in consumption and excludable. Ex. Satellite TV, must pay to receive the signal; more than one consumer can get the signal Common- resource good- rival in consumption but not excludable. Ex. Crab can be caught by only 1 crew, but any boat wants to brave the elements that can catch crab. Cost-benefit analysis It’s a process used to determine whether the benefits of providing a public good outweigh the cost. Internet piracy – illegal form of free-riding. If copyright routinely violated, revenues to private businesses will decline and the amount of music and movies produced will decrease. Copyright laws make the good excludable but non-rival. Common resources and tragedy of the commons Tragedy of commons- a situation that occurs when a good that is rival in consumption but non-excludable becomes depleted. Common ownership leads to overuse. Common property leads to abuse and depletion of the resource. Incentives associated with common property. 1) The incentive to neglect Ex. Ocean is not owned by anyone, fishing ground can’t be protected 2) The incentive to overuse Ex. None has the authority to define how much of a resource can beused. Solution to the tragedy of the commons It requires planning and coordination. Businesses and individuals can be discouraging from producing emission through carbon taxes, internalize the negative externalities. Cap and trade policy- approach to emissions reduction that has received much attention lately. Create the conditions for carbon producers to internalize the externality by establishing markets for tradable emission permits. Ex. Limit the amount of CO2 that can be emitted. Companies that produce fewer carbon emission can sell the permits they didn’t use. Negative consequence- cap and trade presumes that nations can agree on and enforce emission limits, but such agreement have proven difficult to negotiate.


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