14.Complete the following short-run cost table using the information
provided.
Q TC
TFC
TVC AVC
ATC
MC
0$ 4
$_____ $_____ $_____ $_____ $_____
17
_____ _____ _____ _____ _____
29
_____ _____ _____ _____ _____
3 10
_____ _____ _____ _____ _____
4 11
_____ _____ _____ _____ _____
5 13
_____ _____ _____ _____ _____
6 17
_____ _____ _____ _____ _____
7 22
_____ _____ _____ _____ _____
•
•
•
15. Consider the two diagrams below. Diagram A
represents a typical firm in a purely competitive
industry. Diagram B represents the supply and
demand conditions in that industry.
(a) Describe the price, output, and profit
situation for the individual firm in the short run.
(b) Describe what will happen to the individual
firm and the industry in the long run. Show the
changes on diagrams A and B.
•
•
•
Consider the graph below:
Suppose the price of coffee is $1/cup and the price of
sweaters is $20.
How much is the consumer’s budget? (show your work)
sweaters
5
3
IC3
IC2
IC1
40
100
cups
of coffee
P
MC
ATC
D = MR = P
$7
$5
$3
200
•
Q
What is the profit maximizing price
and quantity of the FIRM?
Economic Theory, Markets, and
Government
• Economic Theory
• Market Failure
• The Role of Government
I. Economic Theory
• Elements
• objectives
• constraints
• choices
objectives
• what do we want to do?
• people: maximize satisfaction
• firms: max. profits
• gov't: max. re-election or budget
constraints
• limits on how we achieve objectives
• physical (PPC)
• financial (budget constraint)
• legal (property rights)
choices
• a statement about likely choice
• law of demand
• law of supply
key assumption
• people are rational
•
• people make best decision give
their objectives and constraints
rational decisions are
• consistent
• forward-looking
rationality
• full
•
• use all available info when making
decisions
bounded
• limited ability to process
information
rationality & objectives
• self-regarding preferences
•
• maximize own satisfaction
other-regarding preference
• max. own and others' satisfaction
• care what others think
Theory vs. observation
• combine theory with observation
• simplest theory,
• consistent with observation
What if observations do not match
theory?
• modify theory
•
• have we allowed for all constraints?
• are the objectives correct?
unwilling to change
• preferences
• rationality assumption
II. Market failure
• Usually market allocates resources
optimally
• directs resources to best uses
• market outcome is efficient
• market failure results when
• market outcome is not efficient
• too little of good is produced OR
• too much of good is produced
When does this happen?
• externalities
• public goods
• lack of competition
Externalities
• 3rd party gets costs or benefits from
good
• production or consumption
• OTHER than buyer/seller
• External benefit =
positive externality
• External cost =
negative externality
example: flu shot
Flu shot
• I pay $10 for a flu shot
• I am less likely to get the flu
• AND
• you are less likely to get the flu
• external benefit
So what’s the problem?
• My decision to get flu shot based on
only MY benefits
• underestimate total benefits of
shot
• too few people get shots
• markets under-produce goods with
external benefits
So what’s the solution?
• Government subsidy of flu
shot
-- price is cheaper
-- more people get flu shots
Other goods with external benefits
• education
• antilock brakes
• landscaping
Example: electricity production
• Profits for utility company
• costs to utility company
• external costs
-- air pollution
-- water pollution
So what’s the problem?
• Electricity cost reflects production
•
cost
not pollution costs
• underestimate total costs
• electricity is too cheap
• markets over-produce goods with
external costs
So what’s the solution?
• Government pollution
regulation
• increase costs of electricity
• less power generated
Other goods with external costs
• Cigarette smoking
• loud music
• careless driving
Public goods
• nonexclusive
• cannot exclude those who do
not pay from getting benefits
• nonrival
• my consuming good does not
prevent you from consuming it
• Private good: candy
• if I eat it, you cannot
• Public good:
missile defense
shield over city
• everyone here can use it
So what’s the problem?
• If I buy the shield, you benefit
• so I wait, hoping you buy the
shield….
• nobody buys the shield
• free rider problem
• market alone will fail to produce
the public good
So what’s the solution?
• Gov’t levies taxes to fund
production of public good
• society better off
Other public goods:
• law enforcement
• fire protection
• roads, bridges
Lack of Competition
What is it?
• Firm is large or only supplier
• firm is able to influence price
With no market power
Perfect competition
• many firms
• max output at lowest price
So what’s the problem?
• Firms w/ market power restrict
output
• increasing prices
• anti-competitive behavior
• no incentive to improve quality
So what’s the solution?
• Antitrust laws
• regulate BEHAVIOR
• case against Microsoft
III. Role of Government
• dealing with market failures
•
•
•
•
regulation
subsidies/taxes
anti-trust laws
provision of goods/services
problems
• rent-seeking
• government failure
rent-seeking
• parties lobby gov’t for laws to
protect their interest at expense of
others
• tariffs/quotas
• tax credits
• patent/copyright extention
government failure
• law of unintended consequences
• policies have other effects
• is the cure worse than the
disease?
Private Goods—and Others
What’s the difference between installing a new
bathroom in a house and building a municipal sewage
system?
What’s the difference between growing wheat and
fishing in the open ocean?
In each case there is a basic difference in the
characteristics of the goods involved. Bathroom
appliances and wheat have the characteristics needed to
allow markets to work efficiently; sewage systems and
fish in the sea do not.
Let’s look at these crucial characteristics and why they
matter…
Characteristics of Goods
Goods can be classified according to two attributes:
whether they are excludable and
whether they are rival in consumption
A good is excludable if the supplier of that good can
prevent people who do not pay from consuming it.
A good is rival in consumption if the same unit of
the good cannot be consumed by more than one
person at the same time.
Characteristics of Goods
A good that is both excludable and rival in consumption
is a private good.
When a good is nonexcludable, the supplier cannot
prevent consumption by people who do not pay for it.
A good is nonrival in consumption if more than one
person can consume the same unit of the good at the
same time.
Characteristics of Goods
There are four types of goods:
Private goods, which are excludable and rival in
consumption, like wheat
Public goods, which are nonexcludable and nonrival
in consumption, like a public sewer system
Common resources, which are nonexcludable but
rival in consumption, like clean water in a river
Artificially scarce goods, which are excludable but
nonrival in consumption, like pay-per-view movies on
cable TV
Characteristics of Goods
There are four types of goods. The type of a good depends on (1)
whether or not it is excludable— whether a producer can prevent
someone from consuming it; and (2) whether or not it is rival in
consumption—whether it is impossible for the same unit of a good
to be consumed by more than one person at the same time.
Why Markets Can Supply Only Private Goods
Efficiently
Goods that are both excludable and rival in
consumption are private goods. Private goods can be
efficiently produced and consumed in a competitive
market.
When goods are nonexcludable, there is a free-rider
problem: consumers will not pay producers, leading to
inefficiently low production.
When goods are nonrival in consumption, the
efficient price for consumption is zero. But if a positive
price is charged to compensate producers for the cost of
production, the result is inefficiently low consumption.
Public Goods
A public good is the exact opposite of a private good:
it is a good that is both nonexcludable and nonrival in
consumption.
Here are some other examples of public goods:
Disease prevention. When doctors act to stamp
out the beginnings of an epidemic before it can spread,
they protect people around the world.
National defense. A strong military protects all
citizens.
Scientific research. More knowledge benefits
everyone.
Providing Public Goods
Because most forms of public good provision by the
private sector have serious defects, they must be
provided by the government and paid for with taxes.
How Much of a Public Good Should Be
Provided?
The marginal social benefit of an additional unit of a
public good is equal to the sum of each consumer’s
individual marginal benefit from that unit. At the efficient
quantity, the marginal social benefit equals the
marginal cost.
The following graph illustrates the efficient provision of a
public good…
Providing Public Goods
No individual has an incentive to pay for providing the
efficient quantity of a public good because each
individual’s marginal benefit is less than the marginal
social benefit.
This is a primary justification for the existence of
government.
Cost-Benefit Analysis
Governments engage in cost-benefit analysis when
they estimate the social costs and social benefits of
providing a public good.
Although governments should rely on cost-benefit
analysis to determine how much of a public good to
supply, doing so is problematic because individuals
tend to overstate the good’s value to them.
The Problem of Overuse
Common resources left to the free market suffer from
overuse: a user depletes the amount of the common
resource available to others but does not take this cost
into account when deciding how much to use the
common resource.
In the case of a common resource, the marginal social
cost of my use of that resource is higher than my
individual marginal cost, the cost to me of using an
additional unit of the good.
The following figure illustrates this point…
The Efficient Use and Maintenance of a Common
Resource
To ensure efficient use of a common resource, society
must find a way of getting individual users of the
resource to take into account the costs they impose on
other users.
Like negative externalities, a common resource can be
efficiently managed:
by Pigouvian taxes (tax or otherwise regulate the use
of the common resource)
by making it excludable and assigning property rights,
or by the creation of a system of tradable licenses for
the right to use the common resource.
Artificially Scarce Goods
An artificially scarce good is excludable but nonrival
in consumption.
Because the good is nonrival in consumption, the
efficient price to consumers is zero. However, because it
is excludable, sellers charge a positive price, which leads
to inefficiently low consumption.
It is made artificially scarce because producers charge a
positive price but the marginal cost of allowing one more
person to consume the good is zero.
The problems of artificially scarce goods are similar to
those posed by a natural monopoly.
Artificially Scarce Goods
In this example the market price is $4 and the quantity demanded
in an unregulated market is QMKT. But the efficient level of
consumption is QOPT, the quantity demanded when the price is
zero. The efficient quantity, QOPT, exceeds the quantity
demanded in an unregulated market, QMKT. The shaded area
represents the loss in total surplus from charging a price of $4.
• A Policeman’s Lot
1.
Law enforcement is an example of:
A)
a public good.
B)
a private good.
C) a negative externality.
D) moral hazard.
• A Policeman’s Lot
1.
Law enforcement is an example of:
A)
a public good.
B)
a private good.
C) a negative externality.
D) moral hazard.
• A Policeman’s Lot
2.
The security and alarm system at a bank is an example of:
A)
a public good.
B)
a private good.
C) a negative externality.
D) moral hazard.
• A Policeman’s Lot
2.
The security and alarm system at a bank is an example of:
A)
a public good.
B)
a private good.
C) a negative externality.
D) moral hazard.
• A Policeman’s Lot
3.
People in a community would not be likely to voluntarily
“chip in” for a security team that would patrol the entire
community because:
A)
most people are not rational consumers.
B)
they can be free-riders.
C) they believe that crime cannot be prevented.
D) they believe it would be an inefficient production of the
service.
• A Policeman’s Lot
3.
People in a community would not be likely to voluntarily
“chip in” for a security team that would patrol the entire
community because:
A)
most people are not rational consumers.
B)
they can be free-riders.
C) they believe that crime cannot be prevented.
D) they believe it would be an inefficient production of the
service.
HINT
•
Four Types of Goods
DEFINITIONS
There are four types of goods, depending on whether or
not the good is excludable and whether or not it is rival
in consumption. They are:
• Private goods: these are rival in consumption
and excludable
• Common resources: these are rival in
consumption and nonexcludable
• Artificially scarce goods: these are nonrival in
consumption and excludable
• Public goods: these are nonrival in
consumption and nonexcludable
Goods that are nonexcludable suffer from the freerider problem: individuals have no incentive to pay for
their own consumption and instead will take a “free ride”
on anyone who does pay.
TEST YOUR UNDERSTANDING
4.
Which of the following goods best fit the characteristics of a
private good?
A)
national defense
B)
clean water
C) a pizza
D) police protection
TEST YOUR UNDERSTANDING
4.
Which of the following goods best fit the characteristics of a
private good?
A)
national defense
B)
clean water
C) a pizza
D) police protection
TEST YOUR UNDERSTANDING
5.
Which of the following goods is most likely a public good?
A) the Internet
B)
a public park
C) a pair of pants
D) fire protection provided by the local fire department
TEST YOUR UNDERSTANDING
5.
Which of the following goods is most likely a public good?
A) the Internet
B)
a public park
C) a pair of pants
D) fire protection provided by the local fire department
SUMMARY
• Law enforcement is a public good because the
benefits of tracking down criminals and bringing
them to justice, and of policing public areas,
accrue to all law-abiding citizens.
HINT
•
The Marginal Social
Benefit Curve
DEFINITIONS
Public goods are both nonexcludable and
nonrival in production.
At the efficient quantity of a public good, the
marginal social benefit is equal to the marginal
social cost.
Governments provide public goods because an
individual’s marginal benefit is less than the
marginal social benefit, and so individuals do not
have an incentive to pay for providing the efficient
quantity of the public good.
TEST YOUR UNDERSTANDING
4.
No individual is willing to pay for providing the efficient level of a
public good since the:
A)
marginal cost of production is zero.
B)
good will be nonrival, and thus underconsumed.
C) individual's marginal benefit is less than the marginal social
benefit.
D) marginal benefit of allowing one more individual to consume
the good is zero.
TEST YOUR UNDERSTANDING
4.
No individual is willing to pay for providing the efficient level of a
public good since the:
A)
marginal cost of production is zero.
B)
good will be nonrival, and thus underconsumed.
C) individual's marginal benefit is less than the marginal social
benefit.
D) marginal benefit of allowing one more individual to consume
the good is zero.
TEST YOUR UNDERSTANDING
5.
Public goods should be produced up to the point where the
marginal cost of production equals:
A)
the maximum price any individual is willing to pay for that
unit.
B) the sum of the individual marginal benefits from all
consumers of that unit.
C) zero, which is the marginal cost of allowing another
individual to consume the good.
D) the highest marginal benefit from any individual consumer of
the good.
TEST YOUR UNDERSTANDING
5.
Public goods should be produced up to the point where the
marginal cost of production equals:
A)
the maximum price any individual is willing to pay for that
unit.
B) the sum of the individual marginal benefits from all
consumers of that unit.
C) zero, which is the marginal cost of allowing another
individual to consume the good.
D) the highest marginal benefit from any individual consumer of
the good.
SUMMARY
• The problem with the government provision of
public goods is that everyone wants a project that
benefits his or her property—if other people are
going to pay for it.
• In the United States, the Army Corps of
Engineers has undertaken projects that cannot be
justified by any reasonable cost-benefit analysis.
HINT
•
A Common
Resource
DEFINITIONS
A common resource is nonexcludable and rival in
consumption. As a result, common resources left to the
market are likely to suffer from overuse.
There are three fundamental ways to induce people
who use common resources to internalize the costs
they impose on others:
• Tax or otherwise regulate the use of the common
resource
• Create a system of tradable licenses for the right
to use the common resource
• Make the common resource excludable and
assign property rights to some individuals
TEST YOUR UNDERSTANDING
4.
Common resources tend to be overused because:
A)
individuals tend to ignore the cost of their use of the
resource to others.
B)
the individual marginal cost is greater than the marginal
social cost.
C) common resources are nonrival and nonexcludable.
D) the marginal cost of allowing 1 more unit of consumption is
zero.
TEST YOUR UNDERSTANDING
4.
Common resources tend to be overused because:
A)
individuals tend to ignore the cost of their use of the
resource to others.
B)
the individual marginal cost is greater than the marginal
social cost.
C) common resources are nonrival and nonexcludable.
D) the marginal cost of allowing 1 more unit of consumption is
zero.
TEST YOUR UNDERSTANDING
5.
One way the government of Alaska could prevent overuse of
waters for crab fishing would be to:
A)
subsidize fishermen to create more competition.
B)
sell exclusive licenses for the right to fish.
C) offer tax breaks for more efficient boats.
D) do all of the above.
TEST YOUR UNDERSTANDING
5.
One way the government of Alaska could prevent overuse of
waters for crab fishing would be to:
A)
subsidize fishermen to create more competition.
B)
sell exclusive licenses for the right to fish.
C) offer tax breaks for more efficient boats.
D) do all of the above.
SUMMARY
• A common resource is nonexcludable and rival in
consumption. As a result, common resources left
to the market are likely to suffer from overuse.
• One way to avoid this is to make the common
resources excludable and assign property rights
to some individuals through, for example,
licenses to fish.
HINT
•
An Artificially
Scarce Good
DEFINITION
An artificially scarce good is excludable but
nonrival in consumption.
Because the good is nonrival in consumption, the
efficient price to consumers is zero. However,
since the good is excludable, sellers charge a
positive price, which leads to inefficiently low
consumption.
TEST YOUR UNDERSTANDING
4.
Which of the following is an example of an artificially scarce good?
A)
diamonds, because their supply is artificially restricted by
monopoly producers
B)
music that is downloadable from the Internet for a fee
C) a daily newspaper
D) hot dogs in a sports stadium because the number of
suppliers is restricted
TEST YOUR UNDERSTANDING
4.
Which of the following is an example of an artificially scarce good?
A)
diamonds, because their supply is artificially restricted by
monopoly producers
B)
music that is downloadable from the Internet for a fee
C) a daily newspaper
D) hot dogs in a sports stadium because the number of
suppliers is restricted
TEST YOUR UNDERSTANDING
5.
Artificially scarce goods are inefficiently consumed because the
market price is zero.
A)
True.
B)
False.
TEST YOUR UNDERSTANDING
5.
Artificially scarce goods are inefficiently consumed because the
market price is zero.
A)
True.
B)
False.
SUMMARY
• Games are blacked out at the insistence of team
owners who don’t want people who might have
paid for tickets staying home and watching the
game on TV instead.