Elasticity, Market Failures (Ch 5&6) – Flashcards
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externality
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a benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service
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private cost
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the cost borne by the producer of a good or service
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social cost
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the total cost of producing a good or service, including both the private cost and any external cost
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private benefit
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the benefit received by the consumer of a good or service
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social benefit
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the total benefit from consuming a good or service, including both the private benefit and any external benefit
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when there is a negative externality in production of a good or service...
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too much of the good or service will be produced at market equilibrium ex: generation of electricity (people with homes on a lake from which fish and wildlife have disappeared because of acid rain have incurred a cost, even though they might not have bought their electricity from the polluting utility)
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when there is a positive externality in consuming a good or service...
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too little of the good or service will be produced at market equilibrium ex: production of college educations because people who do not pay for them will nonetheless benefit from them
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market failure
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a situation in which the market fails to produce the efficient level of output
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property rights
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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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externalities and market failures result from...
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incomplete property rights or from the difficulty of enforcing property rights in certain situations
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transaction costs
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the costs in time and other resources that parties incur in the process of agreeing to and carrying out an exchange of goods and services (time, other costs of negotiating an agreement, drawing up a binding contract, and monitoring the agreement) *when many people are involved, these costs are often higher than the net benefits from reducing the externality (cost of transaction exceeds gain from transaction...private solution to externality problem is not feasible)
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coarse theroem
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the argument of economist ronald coarse that if transactions costs are low, private bargaining will result in an efficient solution to the problem of externalities
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command-and-control approach
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a policy that involves the gov't imposing quantitative limits on the amount of pollution firms are allowed to emit or requiring firms to install specific pollution control devices
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pigovian taxes and subsidies
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gov't taxes and subsidies intended to bring about an efficient level of output in the presence of externalities *the gov't should impose a tax equal to the cost of the externality so the company has to internalize the externality-->cost of externality will become a private cost borne by utilities, and supply curve shifts up *gov't can deal with positive externality in consumption by giving consumers a subsidy, or payment, equal to the value of the externality (students internalize externality-external benefit from college education will become a private benefit received by students) and demand curve shifts right
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rivlary
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the situation that occurs when one person consuming a unit of a good means no one else can consume it
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excludability
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the situation in which anyone who does not pay for a good cannot consume it
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private good
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a good that is both rival and excludable ex: food, clothing, haircuts, big macs
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public good
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a good that is both nonrival and nonexcludable ex: national defense, court system
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quasi-public good
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nonrival but excludable ex: cable tv, toll roads
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free riding
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benefitting from a good without paying for it
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common resource
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a good that is rival but not excludable ex: tuna in the ocean, public pasture land
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tragedy of the commons
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the tendency for a common resource to be overused
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the economically efficient level of pollution reduction
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the marginal benefit received from eliminating another ton of sulfur dioxide declines as sulfur dioxide emissions are reduced as the level of pollution falls, further reductions become increasingly costly
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the net benefit to society from reducing pollution is equal to...
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the difference between the benefit of reducing pollution and the cost
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cap and trade system of tradable emission allowances
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gov't gave allowances to utilities equal to the total target amount of sulfur dioxide emissions. the utilities were then free to buy and sell the allowances
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demand curve for a good represents...(private good)
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the MB the consumer receives from the good (add HORIZONTAL individual demand curves to find market demand curve, and can also find marginal social benefit curve for this good, assuming there is no externality) *keeps price on graph constant
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demand curve for a good represents...(public good)
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the total dollar amount consumers as a group would be willing to pay for that quantity of the public good (add individual demand curves VERTICALLY) *keeps quantity on graph constant *optimal quantity will occur where marginal social benefit (demand) curve intersects the marginal social cost (supply) curve
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elasticity
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a measure of how much one economic variable responds to changes in another economic variable
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price elasticity of demand
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the responsiveness of the quantity demanded to a change in price, measured by dividing the percentage change in the quantity demanded of a product by the percentage change in the product's price
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elastic demand
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demand is elastic when the % change in the quantity demanded is greater than the % change in price, so the price elasticity is greater than 1 in absolute value
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inelastic demand
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demand is inelastic when the % change in quantity demanded is less than the % change in price, so the price elasticity is less than 1 in absolute value
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unit-elastic demand
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demand is unit elastic when the % change in quantity demanded is equal to the % change in price, so the price elasticity is equal to 1 in absolute value
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perfectly inelastic demand
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the case where the quantity demanded is completely unresponsive to price and the price elasticity of demand equals zero ex: insulin
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perfectly elastic demand
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the case where the quantity demanded is infinitely responsive to price and the price elasticity of demand equals infinity
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the key determinants of price elasticity of demand
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the availability of close substitutes to the good, the passage of time, whether the good is a luxury or a necessity, the definition of the market, the share of the good in the consumer's budget
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availability of close substitutes
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if a product has more substitutes available, it will have more elastic demand (pizza). If a product has fewer substitutes available, it will have less elastic demand (gas)
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passage of time
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the more time that passes, the more elastic the demand for a product becomes
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luxuries vs. necessities
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the demand curve for a luxury is more elastic than the demand curve for a necessity
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definition of the market
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the more narrowing we define a market, the more elastic demand will be
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share of a good in a consumer's budget
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the demand for a good will be more inelastic the larger the share of the good in the average consumer's budget (salt would be relatively inelastic)
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total revenue
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the total amount of funds a seller receives from selling a good or service, calculated by multiplying price per unit by the number of units sold
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when demand is inelastic...
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price and total revenue move in the same direction
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when demand is elastic...
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price and total revenue move inversely
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when demand is unit-elastic...
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revenue is unaffected
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cross-price elasticity of demand
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the % change in the Q demanded of one good divided by the % change in the price of another good
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income elasticity of demand
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a measure of the responsiveness of the Q demanded to changes in income, measured by the % change in the quantity demanded divided by the % change in income
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price elasticity of supply
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the responsiveness of the quantity supplied to a change in price, measured by dividing the % change in Q supplied of a product by the % change in the product's price
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the supply curve for a good will be inelastic if we measure it over a short period of time
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it will be increasingly elastic the longer the period of time over which we measure it
