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Principles of Microeconomics: Econ102

Provide the Rules Contract Law Tort Law Corporation Law Private Property Rights

Promote or Maintain Competition Antitrust Laws: Sherman Act, Clayton Act

The Fallacy of Composition

Merit Goods

Redistribution of Income

Provide Public Goods

Correct for Externalities Negative Positive

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Private good: A good that is both rival and excludable.

Public good: A good that is both non-rivalrous, non-excludable and collective.

Free riding: Benefiting from a good without paying for it………….freeloader, freerider

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Rivalry:

The situation that occurs when one person’s consuming a unit of a good means no one else can consume it.

Excludability:

The situation in which anyone who does not pay for a good cannot consume it.

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…………because the market itself fails to provide what consumers desire. Only the government has the legal power to force people to pay.

Society’s well-being is enhanced when government provides a public good whose total benefit exceeds its total costs.

Unfortunately, majority voting does not always deliver that outcome

Inefficient Voting OutcomesInefficient “no” voteInefficient “yes” vote

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Externality:

A benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service.

Negative Externality:

A situation where external costs are borne by someone who is not directly involved in the production of a good or service.

Positive Externality:

A situation where external benefits accrue to someone who is not directly involved in the consumption of a good or service.

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Externalities May Result in Market Failure

Market failure:

A situation in which the market fails to produce the efficient level of output.

What Causes Externalities?

Property rights:

The rights individuals or businesses have to the exclusive use of their property, including the right to buy or sell it.

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Private cost: The cost borne by the producer of a good or service.

Social cost: The total cost of producing a good, including both the private cost and any external cost.

Private benefit: The benefit received by the consumer of a good or service.

Social benefit: The total benefit from consuming a good or service, including both the private benefit and any external benefit.

The Effect of Externalities

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The Effect of Pollution on Economic Efficiency

When there Is a Negative Externality, there is an overproduction of the

good, and therefore an over-allocation of resources

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When there Is a Negative Externality, the following will correct for the market failure:

Individual Bargaining

Liability Rules & Lawsuits

Tax on ProducersPigovian Tax

Direct Controls

Market-Based ApproachesMarket for externality rights

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The Effect of a Positive Externality on Efficiency

When there Is a Positive Externality, there is an underproduction of the

good, and therefore an under-allocation of resources

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When There Is a Positive Externality, a Subsidy Can Bring about the Efficient Level of Output

When there Is a Positive Externality, the following will correct for the market failure:

Individual Bargaining

Subsidy to Consumers

Subsidy to Producers

Government Provision

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Asymmetric Information

Market failure

Incomplete information for buyers or sellers

Better information is too costly

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Moral Hazard problem defined: Is the tendency of one party to a contract or agreement to

alter her or his behavior, after the contract is signed, in ways that could be costly to the other party.

Examples: Drivers may be less cautious. Guaranteed contracts for professional athletes may

reduce the quality of their performance. Unemployment compensation insurance may lead

some workers to shirk Medical malpractice insurance may increase the

amount of malpractice.

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Adverse selection defined: Arises when information known by the first party to a

contract or agreement is not known by the second, and as a result, the second party incurs major costs.

Adverse selection happens at the time the contract is signed

Examples: Used/New Car market Housing market CDO market

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