Agenda Review AP Exam Progress Review Unit Test Review Begin Discussion of Market Failures Homework – Online (see due date)

AP Exam Progress Chapters 1, 2, 37 (12%) –Basic Economic Concepts –Comparative Advantage Chapters 3,4 (20%) –Supply & Demand –Elasticity Chapter 5 (8%) –Market Failures

Unit Exam Results 34 Students 14 As Average 84% Trouble Area: Elasticity Relationship between Revenue and Elasticity Grade of B or less. Optional Assignment. 10 Questions (5 points).

Units I, II, and II Exam Review 13. If products C and D are close substitutes, an increase in the price of C will: A.tend to cause the price of D to fall. B.shift the demand curve of C to the left and the demand curve of D to the right. C.shift the demand curve of D to the right. D.shift the demand curves of both products to the right.

23. The price elasticity of demand for widgets is Assuming no change in the demand curve for widgets, a 16 percent increase in sales implies a: A.1 percent reduction in price. B.12 percent reduction in price. C.40 percent reduction in price. D.20 percent reduction in price.

24. Suppose that the above total revenue curve is derived from a particular linear demand curve. That demand curve must be: A. inelastic for price declines that increase quantity demanded from 6 units to 7 units. B. elastic for price declines that increase quantity demanded from 6 units to 7 units. C. inelastic for price increases that reduce quantity demanded from 4 units to 3 units. D. elastic for price increases that reduce quantity demanded from 8 units to 7 units. 25. Suppose the above total revenue curve is derived from a particular linear demand curve. That demand curve must be: A. inelastic for price declines that increase quantity demanded from 2 units to 3 units. B. elastic for price declines that increase quantity demanded from 5 units to 6 units. C. inelastic for price increases that reduce quantity demanded from 4 units to 3 units. D. elastic for price increases that reduce quantity demanded from 4 units to 3 units.

34.Refer to the table for a certain product market in Econland. If the world price for this product were $6, then Econland would import: A. 400 units and domestic producers would supply 1,400 B. 800 units and domestic producers would supply 1,400 C. 800 units and domestic producers would supply 2,200 D. 400 units and domestic producers would supply 2,200

Market Failures: Public Goods and Externalities 05 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Role of Government List 2 Areas where you strongly feel government needs to do more/less? Why? –Problem –Solution

Market Failures Market fails to produce the right amount of the product Resources may be: Over-allocated Under-allocated LO1 5-10

Demand-Side Failures Impossible to charge consumers what they are willing to pay for the product Some can enjoy benefits without paying LO1 5-11

Supply-Side Failures Occurs when a firm does not pay the full cost of producing its output External costs of producing the good are not reflected in supply LO1 5-12

Attempt to Categorize Shared Consumption EXCLUSION NOYES Pure Private Goods Examples: Donuts, DQ Blizzard, Pumpkin Spice Latte, Gyros, Yoga Pants Toll Goods: Cable TV, 355, 294 NOCommon-pool resources: Fish from Great Lakes & Ocean, Water from the River for Irrigation or Drinking Pure Public Goods: National Defense, Legal System

Efficiently Functioning Markets Demand curve must reflect the consumers full willingness to pay Supply curve must reflect all the costs of production LO1 5-14

Consumer Surplus Difference between what a consumer is willing to pay for a good and what the consumer actually pays Extra benefit from paying less than the maximum price LO2 5-15

Consumer Surplus LO2 Consumer Surplus (1) Person (2) Maximum Price Willing to Pay (3) Actual Price (Equilibrium Price) (4) Consumer Surplus Bob$13$8$5 (=$13-$8) Barb128 4 (=$12-$8) Bill118 3 (=$11-$8) Bart108 2 (=$10-$8) Brent98 1 (= $9-$8) Betty88 0 (= $8-$8) 5-16

Consumer Surplus LO2 Price (per bag) Quantity (bags) D Q1Q1 P1P1 Consumer Surplus Equilibrium Price 5-17

Producer Surplus Difference between the actual price a producer receives and the minimum price they would accept Extra benefit from receiving a higher price LO2 5-18

Producer Surplus LO2 Producer Surplus (1) Person (2) Minimum Acceptable Price (3) Actual Price (Equilibrium Price) (4) Producer Surplus Carlos$3$8$5 (=$8-$3) Courtney48 4 (=$8-$4) Chuck58 3 (=$8-$5) Cindy68 2 (=$8-$6) Craig78 1 (=$8-$7) Chad88 0 (=$8-$8) 5-19

Producer Surplus LO2 Price (per bag) Quantity (bags) S Q1Q1 P1P1 Equilibrium price Producer surplus 5-20

Efficiency Revisited LO2 Price (per bag) Quantity (bags) S Q1Q1 P1P1 D Consumer surplus Producer surplus 5-21

Quantity (bags) Price (per bag) Efficiency Losses LO2 c S Q1Q1 Q2Q2 D b d a e Efficiency loss from underproduction 5-22

Efficiency Losses LO2 c S Q1Q1 Q3Q3 D b f a g Quantity (bags) Price (per bag) Efficiency loss from overproduction 5-23

Private Goods Produced in the market by firms Offered for sale Characteristics Rivalry Excludability LO3 5-24

Public Goods Provided by government Offered for free Characteristics Nonrivalry Nonexcludability Free-rider problem LO3 5-25

Demand for Public Goods LO3 Demand for a Public Good, Two Individuals (1) Quantity of Public Good (2) Adams’ Willingness to Pay (Price) (3) Benson’s Willingness to Pay (Price) (4) Collective Willingness to Pay (Price) 1$4+$5=$9 23+4=7 32+3=5 41+2=3 50+1=1 5-26

Demand for Public Goods LO3 $ P Q $ P Q Adams Benson D1D1 D2D2 Adams’ Demand Benson’s Demand $3 for 2 Items $4 for 2 Items $1 for 4 Items $2 for 4 Items $ P Q Collective Demand and Supply DCDC S Collective Demand $7 for 2 Items $3 for 4 Items Connect the Dots Optimal Quantity Collective Willingness To Pay 5-27

Cost-Benefit Analysis Cost Resources diverted from private good production Private goods that will not be produced Benefit The extra satisfaction from the output of more public goods LO3 5-28

Cost-Benefit Analysis LO3 Cost-Benefit Analysis for a National Highway Construction Project (in Billions) (1) Plan (2) Total Cost of Project (3) Marginal Cost (4) Total Benefit (5) Marginal Benefit (6) Net Benefit (4) – (2) No new construction $0 A: Widen existing highways 4$45$51 B: New 2-lane highways C: New 4-lane highways D: New 6-lane highways

Quasi-Public Goods Could be provided through the market system Because of positive externalities the government provides them Examples: education, streets, libraries LO3 5-30

The Reallocation Process Government Taxes individuals and businesses Takes the money and spends on production of public goods LO3 5-31

Externalities A cost or benefit accruing to a third party external to the transaction Positive externalities Too little is produced Demand-side market failures Negative externalities Too much is produced Supply side market failures LO4 5-32

Externalities LO4 (a) Negative externalities (b) Positive externalities 0 D S StSt Overallocation Negative Externalities StSt Underallocation Positive Externalities QoQo QoQo QeQe QeQe P P 0 QQ D DtDt a c z x b y 5-33

Government Intervention Correct negative externalities Direct controls Specific taxes Correct positive externalities Subsidies and government provision LO4 5-34

Government Intervention LO4 (a) Negative Externalities D S StSt Overallocation Negative Externalities QoQo QeQe P 0 Q a c b (b) Correct externality with tax D S StSt QoQo QeQe P 0 Q a T 5-35

Government Intervention LO4 (a) Positive Externalities 0 StSt Underallocation Positive Externalities QoQo QeQe D DtDt z x y (b) Correcting via a subsidy to consumers 0 StSt QoQo QeQe D DtDt (c) Correcting via a subsidy to producers 0 S' t QoQo QeQe D Subsidy StSt U 5-36

Government Intervention LO4 Methods for Dealing with Externalities Problem Resource Allocation OutcomeWays to Correct Negative externalities (spillover costs) Overproduction of output and therefore overallocation of resources 1.Private bargaining 2.Liability rules and lawsuits 3.Tax on producers 4.Direct controls 5.Market for externality rights Positive externalities (spillover benefits) Underproduction of output and therefore underallocation of resources 1.Private bargaining 2.Subsidy to consumers 3.Subsidy to producers 4.Government provision 5-37

Society’s Optimal Amounts LO5 0 Society’s Marginal Benefit and Marginal Cost of Pollution Abatement (Dollars) Q1Q1 MB MC Socially Optimal Amount Of Pollution Abatement 5-38

Government’s Role in the Economy Government can have a role in correcting externalities Officials must correctly identify the existence and cause Has to be done in the context of politics LO5 5-39

Controlling Carbon Dioxide Emissions Cap and trade Sets a cap for the total amount of emissions Assigns property rights to pollute Rights can then be bought and sold Carbon tax Raises cost of polluting Easier to enforce 5-40