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Pitt ECON 0100 - Government Actions in Markets

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ECON 100 1st Edition Lecture 9Outline of Last Lecture I. Resource Allocation MethodsA. Market PriceB. CommandC. Majority RuleD. ContestE. First-Come, First-ServedF. LotteryG. Personal CharacteristicsH. ForceII. Benefit, Cost, and SurplusA. ValueB. Individual Demand, Market Demand, Consumer SurplusC. Individual Supply, Market Supply, Producer Surplus Outline of Current Lecture I. Is the Competitive Market Efficient A. Efficiency of Competitive EquilibriumB. The Invisible Hand C. Market Failure1. Sources of Market FailureD. Alternatives to the Market1. Ideas About FairnessII. Housing Market with a Rent CeilingA. Housing Shortage, Increased Search Activity, Black MarketB. Inefficiency C. FairnessCurrent Lecture- Is the Competitive Market Efficient - Efficiency of Competitive Equilibrium A competitive market creates an efficient allocation of resources at equilibrium (quantity demanded equals the quantity supplied) When production is:a. Less than the equilibrium quantity, MSB>MSCThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.b. Greater than the equilibrium quantity, MSC>MSBc. Equal to the equilibrium quantity, MSC = MSB Resources are used efficiently when marginal social benefit equals marginal social cost When the efficient quantity is produced, total surplus (the sum of consumer surplus and producer surplus) is maximized- The Invisible Hand Adam Smith’s “invisible hand” idea in the Wealth of Nations implied that competitive markets send resources to their highest valued use in society Consumers and producers pursue their own self-interest and interact in markets Market transactions generate an efficient—highest valued—use of resources- Market Failure Market failurearises when a market delivers an inefficient outcome Market failure can occur because a. Too little of an item is produced (underproduction) – a deadweight loss equals the decrease in total surplus this loss is a social lossb. Too much of an item is produced (overproduction) - a deadweight loss arises from overproduction  this loss is a social loss Sources of Market Failure 1. Price and Quantity Regulationsa. Price regulations sometimes put a block on the price adjustments and lead to underproductionb. Quantity regulations that limit the amount that a farm is permitted to produce also lead to underproduction2. Taxes and Subsidiesa. Taxes increase the prices paid by buyers and lower the prices receivedby sellers so taxes decrease the quantity produced and lead to underproductionb. Subsidies lower the prices paid by buyers and increase the prices received by sellers so subsidies increase the quantity produced and lead to overproduction3. Externalities a. An externality is a cost or benefit that affects someone other than the seller or the buyer of a good  an electric utility creates an external cost by burning coal that creates acid rain the utility doesn’t consider this cost when it chooses the quantity of power to produce  overproduction resultsb. An apartment owner would provide an externalbenefit if she installed a smoke detector  but she doesn’t consider her neighbor’s marginalbenefit and decides not to install a smoke detector  the result is underproduction4. Public Goods and Common Resourcesa. A public good benefits everyone and no one can be excluded from its benefitsb. It is in everyone’s self-interest to avoid paying for a public good (calledthe free-rider problem), which leads to underproductionc. A common resource is owned by no one but can be used by everyoned. It is in everyone’s self interest to ignore the costs of their own use of acommon resource that fall on others (called tragedy of the commons)  the tragedy of the commons leads to overproduction5. Monopoly a. A monopoly is a firm that is the sole provider of a good or serviceb. The self-interest of a monopoly is to maximize its profit; to do so, a monopoly sets a price to achieve its self-interested goalc. As a result, a monopoly produces too little and underproduction results6. High Transaction Costs a. Transactions costs arethe opportunity cost of making trades in a marketb. To use the market price as the allocator of scarce resources, it must beworth bearing the opportunity cost of establishing a marketc. Some markets are just too costly to operate; when transactions costs are high, the market might underproduce- Alternatives to the Market  When a market is inefficient, can one of the non-market methods of allocation do a better job?Often, majority rule might be used But majority rule has its own shortcomings  a group that pursues the self-interest of its members can become the majority Also, with majority rule, votes must be translated into actions by bureaucrats who have their own agendas There is no one efficient mechanism for allocating resources efficiently  butsupplemented majority rule, bypassed inside firms by command systems, andoccasionally using first-come, first-served, markets do an amazingly good job- Ideas about fairness can be divided into two groups: It’s not fair if the result isn’t faira. The idea that only equality brings efficiency is called utilitarianismb. Utilitarianism is the principle that states that we should strive to achieve “the greatest happiness for the greatest number”c. If everyone gets the same marginal utility from a given amount of income,and if the marginal benefit of income decreases as income increases, thentaking a dollar from a richer person and giving it to a poorer person increases the total benefitd. Only when income is equally distributed has the greatest happiness been achievede. Utilitarianism ignores the cost of making income transfers  recognizing these costs leads to the big tradeoffbetween efficiency and fairnessf. Because of the big tradeoff, John Rawls proposed that income should be redistributed to the point at which the poorest person is as well off as possible It’s not fair if the rules aren’t faira. The idea that “it’s not fair if the rules aren’t fair” is based on the symmetry principle (the requirement that people in similar situations be treated similarly)b. In economics, this principle means equality of opportunity, not equality of incomec. Robert Nozick suggested that fairness is based on two rules:1. The state must


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