Transcript Lecture Slide 05

Topic 1(e): Three normative questions
•
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What have we learned about efficiency so far?
If we take as given the quantity of a good, we should:
–
distribute that quantity among consumers such that MBs are
equal.
• or, more strictly, keep allocating the good towards the high
MB consumer and away from the low MB consumer, so long
as such reallocations are feasible.
–
•
have that quantity produced in such a way that MCs are equal
• or, strictly, keep allocating responsibility for production
towards the low MC firm and away from the high MC firm, so
long as such reallocations are feasible.
But what quantity of the good should be produced?
–
The efficient quantity is that where MB=MC.
• or, strictly, we should produce more a good if MB > MC, and
less of a good if MB < MC.
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Topic 1(e): Three normative questions
P
S (MC)
Suppose Q = QL. Then NB = TB - TC
= area A.
Note: we are not specifying a P, so we
say anything about the distribution of
A.
But recall: distribution does not
matter for efficiency.
D (MB)
A
QL
QE
QH
Q
Question: Can we make
NB bigger by choosing a
different Q?
• Yes. If we Q, then NB will .
– NB because TB by more than VC (because MB > MC).
• True until Q to QE.
• Similarly, if Q = QH, if we Q, then NB will .
– NB because TB by less than VC (because MB < MC).
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Topic 1(e): Three normative questions
Only when MB = MC for
the last unit produced
and consumed is it true
that NB is maximized.
P
S (MC)
Maximized NB
D (MB)
QE
Q
Note that this means that the NB generated by the last increment
to Q = 0.
Can define Marginal NB (MNB) = MB - MC.
 The efficient level of output is where MNB = 0.
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Topic 1(e): Three normative questions
P
S (MC)
For instance, if Q = QL, then DWL = A.
NB could  by A if Q to QE.
Note: the existence of DWL 
potential for an increase in NB
A
D (MB)
QL
QE
Q
Consumers’ willingness to
pay for extra Q > VC of
production, by the area A.
Some terminology:
If we have a situation that is inefficient, we know that NB are not
maximized.  Actual NB < potential NB.
Difference between potential NB and actual NB = measure of
efficiency loss.
Deadweight loss (DWL) = potential NB - actual NB
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Topic 1(e): Three normative questions
•
Recall the normative questions :
1.
Who should consume them?
–
2.
MBA = MBB
What quantity of goods should be produced?
–
3.
MC = MB
Who should produce them?
–
MCA = MCB
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Topic 1(f): Market successes
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Positive questions:
1.
What quantity of goods is produced?
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S=D
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If S curve reflects all costs of production and D curve
reflects all benefits from consumption, then MC = MB.
2.
Who does produce them?
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Each producer choose Q where P cuts S.
 MCA = P & MCB = P
 MCA = MCB if producers all face the same price.
3.
Who does consume them?
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Each consumer choose Q where P cuts D.
 MBA = P & MBB = P
 MBA = MBB if consumers all face the same price.
Tells us the conditions that must hold for market outcomes (i.e.
equilibrium) to be efficient (i.e., for markets to succeed). 6
Topic 1(f): Market successes
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Our focus will be on instances where
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The S curve does not really measure all costs
The D curve does not really measure all benefits.
That is, our focus is on markets in which there are externalities.
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Externality: When activities within a market affect those not
directly participating in the market.
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An externality can be negative or positive.
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Externalities can be caused by production or consumption
behavior.
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We will focus on negative production externalities.
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Specifically, where there are environmental costs that firms
might not account for of their own accord.
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Topic 1(f): Market successes
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Our focus will thus be on instances where market outcomes may
not be efficient.
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That is, examples of market failures.
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Our focus will be on market failures arising because some
environmental costs (and benefits) are not accounted for within
markets.
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We will also:
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Examine various policy instruments designed to correct these
market failures.
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Think about ways in which environmental costs and benefits
can be measured.
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