1 of 15 Principles of Microeconomics: Econ102

 Provide the Rules  Contract Law  Tort Law  Corporation Law  Private Property Rights  Promote or Maintain Competition  Antitrust Laws: Sherman Act, Clayton Act  The Fallacy of Composition  Merit Goods  Redistribution of Income  Provide Public Goods  Correct for Externalities  Negative  Positive  Provide Information 2 of 15

 Private good: A good that is both rival and excludable.  Public good: A good that is both non-rivalrous, non-excludable and collective.  Free riding: Benefiting from a good without paying for it………….freeloader, freerider 3 of 15

Rivalry: The situation that occurs when one person’s consuming a unit of a good means no one else can consume it. Excludability: The situation in which anyone who does not pay for a good cannot consume it. 4 of 15

…………because the market itself fails to provide what consumers desire. Only the government has the legal power to force people to pay. Society’s well-being is enhanced when government provides a public good whose total benefit exceeds its total costs.  Unfortunately, majority voting does not always deliver that outcome  Inefficient Voting Outcomes  Inefficient “no” vote  Inefficient “yes” vote 5 of 15

Externality: A benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service. Negative Externality: A situation where external costs are borne by someone who is not directly involved in the production of a good or service. Positive Externality: A situation where external benefits accrue to someone who is not directly involved in the consumption of a good or service. 6 of 15

Externalities May Result in Market Failure Market failure: A situation in which the market fails to produce the efficient level of output. What Causes Externalities? Property rights: The rights individuals or businesses have to the exclusive use of their property, including the right to buy or sell it. 7 of 15

Private cost: The cost borne by the producer of a good or service. Social cost: The total cost of producing a good, including both the private cost and any external cost. Private benefit: The benefit received by the consumer of a good or service. Social benefit: The total benefit from consuming a good or service, including both the private benefit and any external benefit. The Effect of Externalities 8 of 15

The Effect of Pollution on Economic Efficiency When there Is a Negative Externality, there is an overproduction of the good, and therefore an over-allocation of resources 9 of 15

When there Is a Negative Externality, the following will correct for the market failure:  Individual Bargaining  Liability Rules & Lawsuits  Tax on Producers  Pigovian Tax  Direct Controls  Market-Based Approaches  Market for externality rights 10 of 15

The Effect of a Positive Externality on Efficiency When there Is a Positive Externality, there is an underproduction of the good, and therefore an under- allocation of resources 11 of 15

When There Is a Positive Externality, a Subsidy Can Bring about the Efficient Level of Output When there Is a Positive Externality, the following will correct for the market failure:  Individual Bargaining  Subsidy to Consumers  Subsidy to Producers  Government Provision 12 of 15

 Asymmetric Information  Market failure  Incomplete information for buyers or sellers  Better information is too costly 13 of 15

 Moral Hazard problem defined:  Is the tendency of one party to a contract or agreement to alter her or his behavior, after the contract is signed, in ways that could be costly to the other party.  Examples:  Drivers may be less cautious.  Guaranteed contracts for professional athletes may reduce the quality of their performance.  Unemployment compensation insurance may lead some workers to shirk  Medical malpractice insurance may increase the amount of malpractice. 14 of 15

 Adverse selection defined:  Arises when information known by the first party to a contract or agreement is not known by the second, and as a result, the second party incurs major costs.  Adverse selection happens at the time the contract is signed  Examples:  Used/New Car market  Housing market  CDO market 15 of 15