week 6

Question 1

how can price be an incentive?

Answer 1

high price is an incentive for suppliers to produce more. High price is an incentive for buyers to consume less

Question 2

what are internal markets?

Answer 2

markets within companies to buy and sell scarce resources. Companies have figured out how to use lessons from market economies to develop internal markets that help them allocate scare resources to each other for better uses

Question 3

what is the knowledge problem?

Answer 3

occurs when the knowledge needed to make a good decision is not available to the decision maker. The knowledge problem means that managers can’t get the information they need.

Internal markets solve this problem because they do not rely on a centralized decision maker knowing what is best and allocating scare resources

Question 4

what is an externality?

Answer 4

a side effect of an activity that affects bystanders whose interests aren’t taken into account

Question 5

what is a negative externality?

Answer 5

an activity whose side effects harm bystanders ( second hand smoke)

Question 6

what is a positive externality?

Answer 6

an activity whose side effects benefit bystanders ( planting a tree will recycle c02 improving air quality for neighbours)

Question 7

what does negative externality create?

Answer 7

external costs.

Question 8

what is marginal private cost?

Answer 8

The extra cost from one extra unit paid by the seller.

Question 9

what is external cost?

Answer 9

A cost imposed on bystanders

Question 10

what is marginal external cost?

Answer 10

The extra external cost from one extra unit.

Question 11

what is marginal social cost and the formula ?

Answer 11

All marginal costs, no matter who pays them.
Marginal private cost + Marginal external cost

Question 12

what does a negative externality do to the supply curve?

Answer 12

the supply curve is the marginal private cost curve.
so the negative externality creates a marginal external cost so we add these together which equals the marginal social cost which is a left shift in supply

and hence negative externalities yield overproduction

Question 13

what does a positive externality create?

Answer 13

external benefits.

Question 14

what is marginal private benefit

Answer 14

The external benefit from one extra unit enjoyed by the buyer.

Question 15

what is an external benefit

Answer 15

A benefit accruing to bystanders

Question 16

what is a marginal external benefit

Answer 16

The extra external benefit from one extra unit.

Question 17

what is social benefit and the formula

Answer 17

All marginal benefits, no matter who gets them.
Marginal private benefit + Marginal external benefit

Question 18

what does a positive externality do to the demand?

Answer 18

the demand curve is the marginal private benefit curve.
so the positive externality creates a marginal external benefit so we add these together which equals the marginal social benefit curve which is a right shift in demand

So the equilibrium yields underproduction

Question 19

what is the rational rule?

Answer 19

produce more of a product as long as its marginal social benefit is at least as large as the marginal social cost

Question 20

what happens when marginal social benefit is equal to marginal social cost

Answer 20

Is the socially optimal outcome this is the most efficient for society as a whole, including the interests of buyers, sellers, and bystanders

Question 21

what is corrective tax?

Answer 21

a tax designed to encourage or discourage people into the different externalities

Question 22

what is a non excludable goods

Answer 22

products that cannot exclude a certain individual or group of individuals from using them

Question 23

what is a non rival goods

Answer 23

a good which one persons use doesn’t subtract from another

Question 24

what is a free rider problem

Answer 24

a situation arises when someone can enjoy the benefits of a good without bearing the costs.

With non rival good free riders enjoy positive externalities without hurting others. Eg if you clean your flat your flat mates will benefit from the clean flat

Question 25

what is a rival good?

Answer 25

a good that can only be consumed by one person or limited number of people at a time ( a car can only be ridden by one person at time

Question 26

what is a public good

Answer 26

A public good is a commodity or service that is non-rivalrous (one person's use doesn't diminish another's) and non-excludable (it's difficult or impossible to prevent anyone from using it)

Question 27

what is a common resources

Answer 27

A common resource is a resource that is available to everyone ( non excludable) and provides benefits, but decreases in value as more people use it ( rivalarous).

Question 28

what is the tragedy of the commons

Answer 28

The tragedy of the commons is an economic problem where the individual consumes a resource at the expense of society. If an individual acts in their best interest, it can result in harmful over-consumption to the detriment of all

Question 29

Over a six-month period in 2007, the price of corn had increased by almost 70% as a result of increased demand for ethanol biofuel. What signal does the dramatic price increase give buyers?

Answer 29

The higher price signals to suppliers how much buyers value the product, because the price reveals their marginal benefit, or willingness-to-pay. The higher price signals to buyers how expensive it is for sellers to produce more of a product, as it reveals the seller’s marginal cost.

Question 30

Over a six-month period in 2007, the price of corn had increased by almost 70% as a result of increased demand for ethanol biofuel. How does the price change impact buyers’ and farmers’ incentives?

Answer 30

The price change incentivizes buyers to cut back their consumption, because their opportunity cost has increased. Buyers may reduce their consumption by conserving their use and/or switching to substitute goods. The price change incentivizes farmers to expand production, because it creates new profit opportunities

Question 31

Over a six-month period in 2007, the price of corn had increased by almost 70% as a result of increased demand for ethanol biofuel. How do you think buyers and farmers responded to the dramatic price increase?

Answer 31

. Buyers and farmers most likely responded to the price increase by acting in accordance with their individual incentives. Farmers expanded production, and buyers reduced consumption.

Question 32

A local school administrator observes an increase in the number of flu outbreaks in the public schools over the last two years. She is concerned that this is putting other children at risk, so she proposes that the state should subsidize flu shots in order to increase coverage rates. Are the administrator’s concerns valid—are too few children getting flu shots—and will a subsidy lead to a more socially optimal quantity?

Answer 32

Yes, the administrator’s concern is valid from an efficiency perspective. Too few flu shots led to a higher number of flu episodes. An inefficiently low number of individuals will be vaccinated in this market because the external benefit to others will not be taken into account during the decision-making process that the proposed policy will help; a subsidy will reduce the cost to the individual, and as a result, more individuals will find it beneficial to get vaccinated even though they are still only considering their private benefits