The assumption of maximizing behavior lies at the heart of economic
analysis.
Firms are assumed to maximize economic profit.
Economic profit is the difference between total revenue and total
costs.
Cost used in the calculation of economic profit are opportunity costs.
The Analysis of Maximizing Behavior
Marginal benefit is the amount by which an additional unit of an activity
increases its total benefit
Marginal cost is the amount by which an additional unit of an activity
increases its total cost
Marginal decision rule: Net benefit is maximized at the point at which
marginal benefit equals marginal cost.
A constraint is a boundary that limits the range of choices that can
be made
The marginal benefit curve for most activities slopes downwards.
Total benefit equals the area under the marginal benefit curve up to the
quantity of the activity
The marginal cost curve slopes upward.
The area under the marginal cost curve gives total cost.
Net benefit equals total benefit minus total cost.
Deadweight loss is the amount of net benefit given up by a failure to
operate where marginal benefit equals marginal cost.
When the net benefits of all economic activities are maximized, the
allocation of resources is considered efficient. (Allocative Efficient)
The concept of an efficient allocation of resources incorporates both the
production and consumption of goods or services.
Achieving Efficiency
The role of property rights
Property rights are a set of rules that specify the ways in which an owner
can use a resource.
A system of property rights forms the basis for all market exchange
There are two required characteristics of property rights if the marketplace is to be efficient
Exclusivity. An exclusive property right is one that allows its owner to
prevent others from using the resource
Transferability. A transferable property right is one that allows the
owner of a resource to sell or lease it to someone else.
A competitive market with well-defined and transferable property rights
satisfies the efficiency condition.
Producer and Consumer Surplus
Consumer surplus is the amount by which the total benefit to consumers
exceeds their total expenditure
Producer surplus is the difference between the total revenue received by
sellers and their total cost.
Efficiency and Equity
In a market that satisfies the efficiency condition, an efficient allocation
of resources will emerge from any particular distribution of income.
Different income distributions will result in different, but still efficient,
outcomes
There is no test to apply to determine whether the distribution of income
is or is not fair or equitable
The failure of private decisions in the marketplace to achieve an efficient
allocation of resources is called market failure
Noncompetitive Markets
1. Market power is the ability to change the market price by an individual
firm or group of firms
2. Market power results in distorted price, one that does not equal
marginal cost
Public Goods
1. A public good is one for which the cost of exclusion is prohibitive and
for which the marginal cost of an additional user is zero.
2. A private good is one for which exclusion is possible and for which the
marginal cost of another user is positive.
3. Free riders are people or firms that consume a public good without
paying for it.
4. Public goods and the government
a. Most public goods are provided directly by government
b. Private firms under contract with government agencies produce
some public goods
c. Without government intervention in the market for public goods,
the amount of public goods produced is not expected to be that
which maximizes net benefit
External Costs and Benefits
1. An external cost is a cost imposed on others outside of any market
exchange
2. An external benefit is a benefit imposed on others in the absence of
any market agreement
3. External costs and efficiency
a. External costs are not included in a firm’s supply curve
b. The level of output is higher than would be economically efficient
4. External costs and government intervention
a. Government may intervene to mitigate external costs
b. There are different ways for government to intervene.
Government may find a way to force the internalization of external
costs through fees and fines
Government may use direct regulation by outlawing certain
activities
Common Property Resources
1. A common property resources is a resource for which no exclusive
property rights exist
2. There is frequently no adequate incentive to preserve common
property resources
3. When a species faces extinction, it is likely that no one has exclusive
property rights to it