Positive Analysis
-describes what IS happening
Normal Analysis
Prescribes what SHOULD happen
Economic Efficiency
-an outcome is more economically efficient if it yields more economic surplus
-economic surplus=total benefits - total costs
Efficient Outcome
-efficient outcome yields the largest possible economic surplus
Equity
-measure of “ fairness”, where an outcome is equitable if it results in an even distribution of economic benefits amongst the beneficiaries
-NOT THE SAME AS EQUITY
Consumer Surplus
-economic surplus you get from buying something
=1/2*(marginal benefit-Price)
-describes the gain from buying something at a price lower than the highest price you were willing to pay
-total consumer surplus=triangular area under the demand curve
Producer Surplus
-economic surplus received for selling something
=1/2*(Price-marginal cost)
-gain from selling something at a price above the marginal cost you incur from producing that goods or service
-total producer surplus=triangular area below the supply curve
Voluntary Exchange
-buyers and sellers exchange money for goods only if they both want to
-trade is a win-win
- creates both consumer and producer surplus
-buyers and sellers gain from trade
- doesn’t guarantee that buyers and sellers share equally in gains from trade
Understanding Economic Surplus
=consumer surplus + producer surplus
Or marginal benefit - marginal cost
-total economic surplus = triangular area under demand curve and above supply curve
Efficient Production
-producing a given quantity of output at the lowest possible cost
-requires producing each unit at the lowest marginal cost
Efficient Allocation
-allocating goods to create the LARGEST economic surplus
-requires that each good goes to whoever gets the highest marginal benefit from it
Efficient Quantity
-quantity that produces the largest economic surplus
Rational Rule for markets
-produce more of a good if it’s marginal benefit is greater than or equal to its marginal cost
Market Failure
-when market forces of supply and demand lead to an inefficient outcome
Sources of Market Failure
Market Power
-undermines competitive pressure
-if a market doesn’t have many sellers selling identical products then sellers can exploit limited competition by charging higher prices -> underproduction
Sources of Market Failure
Externalities
-create side effects
-arise when choices that buyers and sellers make have side effects on others
Socially Optimal Quantity
-quantity that is most efficient for society as a whole, including interests of buyers, sellers and bystanders
Negative Externality
-side effect that harms bystanders
-choices that impose costs on others
-TOO MUCH of negative externality activities
Positive Externality
-side effect benefits bystanders
-choices that generate benefits for others
-too LITTLE of positive externality activities
Sources of Market Failure
Information Problems
-undermine trust
Private information
-info that one party has but the other doesn’t
-overall result: underproduction, people buy and sell LESS than the efficient quantity
Sources of Market Failure
Irrationality
-leads to bad decisions
-> if buyers don’t follow the rational rule for buyers then the demand may no longer reflect their marginal benefit
-resulting in a lack of achieving efficient allocation
->if sellers don’t follow the rational rule for sellers then supply decisions may not be driven by their marginal costs
-resulting in lack of achieving efficient production
Sources of Market Failure
Government Regulations
-can impede market forces
-taxes lead to lower quantities being bought and sold
-binding price ceilings and floors lead to non-equilibrium quantities being bought and sold
-quantity regulations also lead to non-equilibrium quantities being bought and sold
Conditions for Market Efficiency
1.All parties are price takers->PERFECT COMPETITION
2.Only private value to buyers and sellers matter->NO EXTERNALITY
3.All parties have perfect info->NO PRIVATE INFORMATION
4.All parties strictly follow the rational rule-> RATIONALITY
5. No distortions from govt intervention
