Lecture 5

Question 1

What is the first fundamental theorem of welfare economics?

Answer 1

1. There are markets and market prices for all goods
2. All buyers and sellers are competitive price-takers
3. Each person’s utility depends only on his own consumption

Question 2

Give 2 ways of how markets can fail

Answer 2

1. Markets are not perfectly competitive (Buyer or seller has market power)
2. transactions have externalities

Question 3

What is an externality?

Answer 3

A byproduct of consumption or production that affects someone other than the buyer or seller

can be posititive or negative, depending on whethe rhte impact on the bystander is adverse or beneficial

Question 4

How does externalities make markets inefficient?

Answer 4

what matters is social cost and benefits ( private + external cost and benefits)

self-interested buyers and sellers consider only private cost and benefits of their actions; they neglect the external costs of benefits of thei actions

Question 5

Structure for explainingn market failure in petrol

Answer 5

1. Market eqm maximises consumer surplus anad producer surplus
2. Supply curve shows Private marginal cost(PMC) (cost directly incurred by sellers)
3. Supply curve shows Private marginal benefit (PMB)
4. Social marginal cost is higher than the supply curve by external marginal cost (EMC). EMC represents the value of negative impact to bystanders
5. Only consider the private benefit and cost.
6. Market eqm greater than social optimum

Question 6

Why must a tax be imposed on negative externality?

Answer 6

to INTERNALIZE THE EXTERNALITY

must introduce a tax that exactly equals to the EMC

Question 7

Why is social marginal benefit greater than the private marginal benefit?

Answer 7

Due to presence of external marginal benefit

At every quantity, sum of the marginal private benefit and the external marginal benefti gives us the social marginal benefit

Question 8

What are the 2 types of public policy for externalities?

Answer 8

Command- and-control poliicies to regulate behaviour directly ( eg limit amt of pollution)

market based policies (incentives to take external into acc like tax and sub)

Question 9

What are corrective tax?

Answer 9

Pigouvian Tax

shift supply or demand curve wrt to amount of tax

Question 10

What are the purpose of corrective tax and subsidy?

Answer 10

align private incentives with society’s interests

induce private decision-makers to take into account the external costs and benefits of their actions

move the economy toward a more efficient allocation of resources

NEGATIVE: seller see higher cost

POSITIVE: buyer have higher valuation of good

Question 11

What is coase theorem?

Answer 11

If private parties can costlessly bargain over allocation of resources, they can solve the externalities problem on their own.

Depends on who has the right (eg sibling want to disturb you, vs want to have peace)

Question 12

What is the outcome of coase theorem?

Answer 12

The socially efficient outcome maximizes both Jack’s and Jill’s well-being.

Question 13

the _____ market achieves __ outcome regardless of initial distribution of rights

Answer 13

private
efficient

Question 14

Why do private solutions not always work?

Answer 14

Transaction costs

Stubbornness

Coordination problems ( larger parties make coordinating difficult)

Question 15

What does it mean for a good to be excludable?

Answer 15

person can be prevented from using it.

Question 16

What does it mean for a good to be rival in consumption?

Answer 16

one person’s use of it diminishes other people’s use of it.

Question 17

How does non excludability lead to inefifcient allocation?

Answer 17

Price is a signal that tells seller how much buerys value it and buyers how much sellers take to produce it

When goods have no prices,
the market forces that normally allocate resources are absent.

Question 18

What is rival and non excludable?

Answer 18

Common resources

Question 19

What is not rival and excludable?

Answer 19

Club good/ Natural monopoly

Question 20

How do public goods arise?

Answer 20

Non excludable: people have incentive to free ride

Firms do not produce good even if the cost of providing the good is less than the collective benefit of good

Question 21

How do common resources arise?

Answer 21

Non excludable:
free rider cannot be stopped from using, firms dont provide. GOVT HAVE TO PROVIDE

Rivalrous:
each person use reduces others ability to use it
GOVT ENSURE THEY ARE NOT OVERUSED

Question 22

What does the tragedy of the commons show? How to solve?

Answer 22

shows why common resources overused

Negotiated agreements (players just need to find a way to align their individual incentives with the goals of the group as a whole)

Question 23

What are govt policies to prevent overconsumption of common resources?

Answer 23

Privatise
Regulate
Corrective tax
Permit

Question 24

What is the profit maximisation condition?

Answer 24

Produce as long as MR>=MC

Question 25

What are the formulas for Total revenue, average revenue and maginal revenue?

Answer 25

TR= P x Q
AR= TR/Q = P
MR = dTR/dQ

Question 26

What is marginal revenue?

Answer 26

change in Total Revenue from an additional unit sold

Question 27

When is ATC falling?

Answer 27

MC<ATC. mc is pulling down atc

(WHETHER ATC RISES OR FALLS DEPEND ON COST STRUCTURE)

Question 28

When is ATC rising?

Answer 28

MC>ATC. mc is pulling up atc

(WHETHER ATC RISES OR FALLS DEPEND ON COST STRUCTURE)

Question 29

Where do ATC and MC intersect and why?

Answer 29

ATC curve’s minimum.

If mc is neither pulling up nor pulling down atc, then intersect is at minimum of atc

Question 30

waht and why is the profit max quantity?

Answer 30

Thinking on the margin, if increase q by 1 unit, revenue incerase by mr, cost increase by mc.

If MR > MC, then increase Q to raise profit.

If MR < MC, then decrease Q to raise profit.

Question 31

What are the characteristics of perfect compeittion?

Answer 31

There are many buyers and sellers, causing each buyer or seller is too small to influence the entire market

Sellers offer a standardized product.

Sellers can freely enter or exit the market.

Buyers and sellers are well-informed.

buyer and seller is a price-taker

Question 32

Why does P=mc for perfect comp?

Answer 32

competitive firm can keep increasing its output without affecting the market price.

each unit increase in Q causes revenue to rise by P,
i.e., MR = P.

Question 33

Why is the compeittive market producing at efficeitn qty?

Answer 33

Since MC=MR and P=MR, P=MC

MC is the cost of producing the marginal unit.
P is the value to buyers.
So, the competitive equilibrium is efficient; it maximizes total surplus.

Question 34

A firm’s marginal cost of producing a good always equals the price of the good

True or false

Answer 34

FALSE(Depeneds on the firms cost structure)

Question 35

A firms marginal revenue from selling a good always equal to the price of the good

True or False

Answer 35

False

Question 36

In prisoner Dilemma both players have _____ that lead to ______ outcomes

Answer 36

Dominant strategies

Inefficient