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Microeconomics


 
 

Market Inefficiency

 

Inefficiency

  1. Pareto efficiency: In an efficient market, there are no possible trades that will make one party better off without making another party worse off.

  2. A pareto efficient market requires:

    1. Every producer of a good should have the same marginal costs.

    2. For each item produced, marginal cost should equal marginal benefit.

    3. All consumers should receive the same marginal benefit from the same good.

  3. In a competitive market, it is assumed that the market equilibrium is pareto efficient.

 
 

Deadweight Loss

  1. Deadweight loss is a cost to society caused by government programs, externalities, monopolies, or other market inefficiencies. Policy-makers must weight the benefits of each government program against its costs.

  2. If the level of production in a market is inefficient, there will be a deadweight loss to the society of the producer and consumer surplus.

Deadweight Loss from Taxes

FIGURE 10 Sales tax raises the marginal cost of producing the goods being taxed, shifting the supply curve up by the amount of the tax. The equilibrium price rises less than the amount of the tax, so even though the rectangular part indicated goes to the government, there is still a deadweight loss.

 
 

Other Barriers to Efficiency

  1. Self-interest: Economics often assumes that individuals always act in their self-interest, but some people are altruistic and derive pleasure from helping others.

  2. Nonrational: Economics assumes that people behave rationally, but realistically, all the requirements of the economic model will not be met when making decisions.

  3. Sunk costs: Sunk costs should not be considered in decision-making, but most people consider them because they feel as though something is being lost. Money makes people act in ways that are inconsistent with the economic model.

  4. Uncertainty: Economics assumes there is perfect information in the market, but this is rarely the case, and choices must often be made with limited information.

  5. Asymmetric information: Different people have access to different information about the market.

  6. Moral hazard: People are less careful if they have insurance.

  7. Adverse selection: People who have insurance have the highest risks in the population.

 
 

Public Goods and Externalities

Public Goods

  1. Public goods have two distinct properties and one attendant problem:

    1. Nonrivaly: One person’s increased consumption of the good does not decrease the amount of the good available to others.

    2. Nonexcludability: It is not possible to keep some people from consuming the good.

    3. Free-rider problem: A person cannot be kept from consuming the good even if they don’t contribute to the costs (example: people who don’t pay their taxes still benefit from national defense).

Externalities

  1. Negative externalities occur when the costs of producing or consuming a good affect those who are not involved (example: pollution).

    1. Production level is higher than efficient because the marginal private cost, which the firm uses to make the production decision, is lower than the marginal social cost, which is the actual cost as it affects society.

    2. Firms produce too much and create a deadweight loss for society. Government usually intervenes to make sure not too much of the good is produced.

  2. Positive externalities occur when the benefits of producing or consuming a good affect those who are not involved (example: a safer neighborhood from one household’s purchase of private security).

    1. Consumption is lower than efficient because the marginal private benefit, which consumers use to make the consumption decision, is lower than the marginal social benefit, which is the actual cost as it affects society.

    2. Consumers buy too little and create a deadweight loss for society. Government usually intervenes to make sure enough of the good is produced.