# Chapter 5 PowerPoint

```Agenda
• Review AP Exam Progress
• Review Unit Test Review
• Begin Discussion of Market Failures
• Homework – Online (see due date)
AP Exam Progress
• Chapters 1, 2, 37
(12%)
– Basic Economic Concepts
• Chapters 3,4
(20%)
– Supply &amp; Demand
– Elasticity
• Chapter 5
– Market Failures
(8%)
Unit Exam Results
• 34 Students
• 14 As
• Average 84%
• Trouble Area:
• Elasticity
• Relationship between Revenue and Elasticity
• Grade of B or less. Optional Assignment. 10 Questions (5 points).
Units I, II, and II Exam Review
13. If products C and D are close
substitutes, an increase in the price of C
will:
A. tend to cause the price of D to fall.
B. shift the demand curve of C to the
left and the demand curve of D to
the right.
C. shift the demand curve of D to the
right.
D. shift the demand curves of both
products to the right.
23. The price elasticity of demand for widgets is 0.80. Assuming no
change in the demand curve for widgets, a 16 percent increase in
sales implies a:
A. 1 percent reduction in price.
B. 12 percent reduction in price.
C. 40 percent reduction in price.
D. 20 percent reduction in price.
24. Suppose that the above total revenue curve is derived from a particular linear demand curve.
That demand curve must be:
A. inelastic for price declines that increase quantity demanded from 6 units to 7 units.
B. elastic for price declines that increase quantity demanded from 6 units to 7 units.
C. inelastic for price increases that reduce quantity demanded from 4 units to 3 units.
D. elastic for price increases that reduce quantity demanded from 8 units to 7 units.
25. Suppose the above total revenue curve is derived from a particular linear demand curve.
That demand curve must be:
A. inelastic for price declines that increase quantity demanded from 2 units to 3 units.
B. elastic for price declines that increase quantity demanded from 5 units to 6 units.
C. inelastic for price increases that reduce quantity demanded from 4 units to 3 units.
D. elastic for price increases that reduce quantity demanded from 4 units to 3 units.
34.
Refer to the table for a certain product market in
Econland. If the world price for this product were \$6, then
Econland would import:
A. 400 units and domestic producers would supply 1,400
B. 800 units and domestic producers would supply 1,400
C. 800 units and domestic producers would supply 2,200
D. 400 units and domestic producers would supply 2,200
05
Market Failures: Public Goods and
Externalities
McGraw-Hill/Irwin
Role of Government
• List 2 Areas where you strongly feel
government needs to do more/less? Why?
– Problem
– Solution
Market Failures
• Market fails to produce the right
•
LO1
amount of the product
Resources may be:
• Over-allocated
• Under-allocated
5-10
Demand-Side Failures
• Impossible to charge consumers
what they are willing to pay for the
product
• Some can enjoy benefits without
paying
LO1
5-11
Supply-Side Failures
• Occurs when a firm does not pay
the full cost of producing its output
• External costs of producing the
good are not reflected in supply
LO1
5-12
Attempt to Categorize
Shared Consumption
NO
YES
YES
Pure Private Goods
Examples: Donuts, DQ
Blizzard, Pumpkin Spice
Latte, Gyros, Yoga Pants
Toll Goods:
Cable TV, 355,
294
NO
Common-pool resources:
Fish from Great Lakes &amp;
Ocean, Water from the River
for Irrigation or Drinking
Pure Public
Goods: National
Defense, Legal
System
EXCLUSION
Efficiently Functioning Markets
• Demand curve must reflect the
•
LO1
consumers full willingness to pay
Supply curve must reflect all the costs
of production
5-14
Consumer Surplus
• Difference between what a consumer
•
LO2
is willing to pay for a good and what
the consumer actually pays
Extra benefit from paying less than
the maximum price
5-15
Consumer Surplus
Consumer Surplus
(2)
Maximum
Price Willing
to Pay
(3)
Actual Price
(Equilibrium
Price)
Bob
\$13
\$8
\$5 (=\$13-\$8)
Barb
12
8
4 (=\$12-\$8)
Bill
11
8
3 (=\$11-\$8)
Bart
10
8
2 (=\$10-\$8)
Brent
9
8
1 (= \$9-\$8)
Betty
8
8
0 (= \$8-\$8)
(1)
Person
LO2
(4)
Consumer
Surplus
5-16
Price (per bag)
Consumer Surplus
Consumer
Surplus
Equilibrium
Price
P1
D
Q1
Quantity (bags)
LO2
5-17
Producer Surplus
• Difference between the actual price a
•
LO2
price they would accept
Extra benefit from receiving a higher
price
5-18
Producer Surplus
Producer Surplus
(2)
Minimum
Acceptable
Price
(3)
Actual Price
(Equilibrium
Price)
Carlos
\$3
\$8
\$5 (=\$8-\$3)
Courtney
4
8
4 (=\$8-\$4)
Chuck
5
8
3 (=\$8-\$5)
Cindy
6
8
2 (=\$8-\$6)
Craig
7
8
1 (=\$8-\$7)
8
8
0 (=\$8-\$8)
(1)
Person
LO2
(4)
Producer
Surplus
5-19
Price (per bag)
Producer Surplus
Producer
surplus
S
P1
Equilibrium
price
Q1
Quantity (bags)
LO2
5-20
Efficiency Revisited
Price (per bag)
Consumer
surplus
S
P1
Producer
surplus
D
Q1
Quantity (bags)
LO2
5-21
Efficiency Losses
Price (per bag)
a
Efficiency loss
from underproduction
S
d
b
e
D
c
Q2 Q1
Quantity (bags)
LO2
5-22
Efficiency Losses
Price (per bag)
a
Efficiency loss
from overproduction
S
f
b
g
D
c
Q1 Q3
Quantity (bags)
LO2
5-23
Private Goods
• Produced in the market by firms
• Offered for sale
• Characteristics
• Rivalry
• Excludability
LO3
5-24
Public Goods
• Provided by government
• Characteristics
• Nonrivalry
• Nonexcludability
• Free-rider problem
LO3
5-25
Demand for Public Goods
Demand for a Public Good, Two Individuals
(1)
Quantity
of Public
Good
(2)
to Pay (Price)
1
\$4
+
\$5
=
\$9
2
3
+
4
=
7
3
2
+
3
=
5
4
1
+
2
=
3
5
0
+
1
=
1
LO3
(3)
Benson’s
Willingness to
Pay (Price)
(4)
Collective
Willingness
to Pay (Price)
5-26
Demand for Public Goods
Benson’s Demand
\$4 for 2 Items
\$2 for 4 Items
P
\$6
5
4
3
2
1
0
D2
1
2
3
4
Q
5
Benson
\$3 for 2 Items
\$1 for 4 Items
P
\$6
5
4
3
2
1
0
D1
1
2
3
4
Q
5
P
Collective Demand
\$7 for 2 Items
\$3 for 4 Items
S
\$9
Optimal
Quantity
7
5
Collective
Willingness
To Pay
3
Connect the Dots
DC
1
0
1
2
3
4
5
Q
Collective Demand and Supply
LO3
5-27
Cost-Benefit Analysis
• Cost
• Resources diverted from private
•
LO3
good production
• Private goods that will not be
produced
Benefit
• The extra satisfaction from the
output of more public goods
5-28
Cost-Benefit Analysis
Cost-Benefit Analysis for a National Highway Construction Project
(in Billions)
(1)
Plan
(2)
Total Cost
of Project
(3)
Marginal
Cost
(4)
Total
Benefit
(5)
Marginal
Benefit
(6)
Net Benefit
(4) – (2)
No new construction
\$0
A: Widen existing highways
4
\$4
5
\$5
1
B: New 2-lane highways
10
6
13
8
3
C: New 4-lane highways
18
8
22
10
5
D: New 6-lane highways
28
10
26
3
-2
LO3
\$0
\$0
5-29
Quasi-Public Goods
• Could be provided through the market
•
•
LO3
system
Because of positive externalities the
government provides them
Examples: education, streets,
libraries
5-30
The Reallocation Process
• Government
• Takes the money and spends on
production of public goods
LO3
5-31
Externalities
• A cost or benefit accruing to a third
•
•
LO4
party external to the transaction
Positive externalities
• Too little is produced
• Demand-side market failures
Negative externalities
• Too much is produced
• Supply side market failures
5-32
Externalities
P
Negative
Externalities
a
P
St
b
St
y
z
S
Positive
Externalities
Dt
x
c
D
D
Overallocation
0
Qo
Qe
(a)
Negative externalities
LO4
Underallocation
0
Q
Qe
Qo
Q
(b)
Positive externalities
5-33
Government Intervention
• Correct negative externalities
• Direct controls
• Specific taxes
• Correct positive externalities
• Subsidies and government
provision
LO4
5-34
Government Intervention
P
Negative
Externalities
a
b
P
St
St
a
S
T
c
0
LO4
S
D
Overallocation
Qo Qe
Q
D
0
Qo Qe
Q
(a)
(b)
Negative Externalities
Correct externality with
tax
5-35
Government Intervention
y
St
z
St
St
Subsidy
S't
Positive
Externalities
x
Dt
Subsidy Dt
D
D
U
D
Underallocation
0
Qe
Qo
(a)
Positive Externalities
LO4
0
Qe
Qo
(b)
Correcting via a subsidy
to consumers
0
Qe
Qo
(c)
Correcting via a subsidy
to producers
5-36
Government Intervention
Methods for Dealing with Externalities
Problem
Resource Allocation
Outcome
Ways to Correct
Negative externalities
(spillover costs)
Overproduction of output
and therefore
overallocation of
resources
1.
2.
3.
4.
5.
Private bargaining
Liability rules and lawsuits
Tax on producers
Direct controls
Market for externality rights
Positive externalities
(spillover benefits)
Underproduction of output
and therefore
underallocation of
resources
1.
2.
3.
4.
Private bargaining
Subsidy to consumers
Subsidy to producers
Government provision
LO4
5-37
Society’s Marginal Benefit and Marginal
Cost of Pollution Abatement (Dollars)
Society’s Optimal Amounts
MC
Socially
Optimal Amount
Of Pollution
Abatement
MB
0
LO5
Q1
5-38
Government’s Role in the Economy
• Government can have a role in
•
•
LO5
correcting externalities
Officials must correctly identify the
existence and cause
Has to be done in the context of
politics
5-39
Controlling Carbon Dioxide Emissions