Transcript Fundamental concepts of economics -2

Fundamental concepts
of economics -2
Governments Can Sometimes Improve
Market Outcomes.


Market failure occurs when the market fails to
allocate resources efficiently.
When the market fails (breaks down)
government can intervene to promote
efficiency and equity.

Market failure may be caused by
 an externality, which is the impact of one person or
firm’s actions on the well-being of a bystander.
 market power, which is the ability of a single person
or firm to unduly influence market prices.
• An externality refers to the uncompensated
impact of one person’s actions on the well-being
of a bystander.
• Externalities cause markets to be inefficient, and
thus fail to maximize total surplus.
• When the impact on the bystander is adverse, the
externality is called a negative externality.
• When the impact on the bystander is beneficial,
the externality is called a positive externality.
Negative Externalities
Air pollution from road and traffic congestion
Smokers ignore the harmful impact of
toxic passive smoking on non-smokers
External costs of scraping the seabed
Barking dogs (loud pets)
Loud stereos in an apartment building
Positive Externalities
Immunizations
Restored historic buildings
Research into new technologies
Pollution and the Social Optimum
Price of
Aluminum
Social
cost
Cost of
pollution
Supply
(private cost)
Optimum
Equilibrium
Demand
(private value)
0
QOPTIMUM QMARKET
Quantity of
Aluminum

This graph shows the effect
of a negative externality.
The red line represents
society's supply
curve/marginal cost curve
while the black line
represents the marginal
cost curve that the firm or
industry with the negative
externality faces. The
optimal production quantity
is Q', but the negative
externality results in
production of Q*. The
deadweight welfare loss is
shown in gray.
Negative Externalities
 The
intersection of the demand curve and
the social-cost curve determines the
optimal output level.
The
socially optimal output level is less
than the market equilibrium quantity.

Internalizing an externality involves altering
incentives so that people take account of the
external effects of their actions.
Positive Externalities

A technology spillover is a type of positive
externality that exists when a firm’s innovation or
design not only benefits the firm, but enters
society’s pool of technological knowledge and
benefits society as a whole.
Education and the Social Optimum
Price of
Education
Supply
(private cost)
Social
value
Demand
(private value)
0
QMARKET
QOPTIMUM
Quantity of
Education
The Standard of Living Depends on a
Country’s Production.


Almost all variations in living standards are
explained by differences in countries’
productivities.
Productivity is the amount of goods and
services produced from each hour of a worker’s
time.
The Standard of Living Depends on a
Country’s Production.

Standard of living may be measured in different
ways:
 By comparing personal incomes.
 By comparing the total market value of a nation’s
production.