Monday, November 18, 2013 Unit 6 Economics of Information

Perfect Information Asymmetric Information Moral Hazard Adverse Selection Problem must chose from an undesirable selection of goods

- All participants

have equal access to information - Consumers know the prices of other substitutes - Producers have to know the cost of production

- Either the seller

or the buyer has better information (much more likely to happen)

- Protection against - The uniformed side

risks encourages people to take more risks

Only 3 entities in economy: Free Market System

! ! ! ! ! ! ! ! ! ! ! ! !

Private Goods vs. Public Goods

- Pure Private Goals Exclusion is possible cant be shared bought in the market place ex)haircut, airbags, Police and fire protection, potato chips, toothbrush - Mixed Goods ex)college education, cable television,spraying for mosquitos, Public toll
boothsMedicare, National Forest Campgrounds

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- Pure Public Good Nonexclusive Shared consumption use of tax dollars ex)national defense, street lights, canine rabies shots,
When should gov get involved in economy?

- WORKER SAFETY LAWS, BARBER SHOP LICENSES, BANK BAILOUTS - every society needs to decide how much government involvement is desireable
5 Characteristics of Free Markets

- 1. little government involvement in economy: Laissez faire - 2. individuals own resources and determine what to produce, how to produce
and who get it.

- 3. The opportunity to make Profit Gives people Incentive to produce quality

items efficiently

- 4. Wide Variety of goods available to consumers - 5. Competition and Self-Interest work together to regulate the economy - THE GOVS JOB IS TO ENFORCE CONTRACTS, SECURE PROPERTY RIGHTS, AND DEFEND
THE COUNTRY

Example of the Invisible Hand of the free market

- If society wants computers and people are willing to pay higher prices then: business have the INCENTIVE to start making computers to earn PROFIT this leads to more COMPETITION which means lower prices, better quality, and more product variety to maintain profits, firms find more efficient way to produce goods &
services

GOV DOESNT NEED TO GET INVOLVED SINCE THE NEEDS OF SOCIETY ARE
AUTOMATICALLY MET

- Does the free market ever FAIL to meet societys needs?

What is a market failure?

- A situation in which the free-market system fails to satisfy societys wants (when the invisible hand doesnt work) - Private markets do not efficiently bring about the allocation of resources the result: Gov must step in to satisfy societys wants "2

Monday, November 18, 2013 How does the free market fail?

- 4 market failures we will focus on 4 different market failures: - public goods education,aircraft carriers, roads why must the government provide public goods and services? - It is impractical for the free market to provide these goods because
there is little opportunity to earn profit

This is due to the Free-Rider Problem: Free Riders are individuals

that benefit without paying

- people who download music illegally - people who watch a street performer but dont pay - teenagers that live at home and dont have a job - free riders keep firms from making profits - if left to the free market, essential services would be under
produced

- to solve problem, government can: find new ways to punish free riders use tax dollars to provide the service to everyone How do we decide how many public goods we need? - Can the government prevent wild fires in San Diego forever? Ensure that no one ver speeds on the freeway? create a research station on mars? Stop pollution from fossil fuels Make sure everyone in the US has a job? - they use supply and demand demand for public goods - Marginal social benefit of the good determined by citizens
willingness to pay

supply of public goods - the marginal social cost of providing each additional quantity ex) Demand for a new park (each park costs $5) - marginal social benefit (MSB) = marginal social cost (MSC)

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Monday, November 18, 2013 # of park 1 2 3 4 5 Adam willing to pay $4 3 2 1 0 Jill is willing to pay $5 4 3 2 1 Societys demand Marginal social (MSB) cost 9 7 5 3 1 5 5 5 5 5

- externalities (third person side effects) An externality is a third person side effect there are EXTERNAL benefits or external costs to someone other than
the original decision maker

Why are externalities market failures? - the free market fails to include external costs or external benefits - with no government involvement there would be too much of some goods
and too little of others

- ex)smoking cigarettes the free market assumes that the cost of smoking is fully paid by
people who smoke limit smoking

the government recognizes external costs and makes policies to Negative externalities - Situation that results in a COST for a different person other than - 2 marginal costs - ex)Zoram is a chemical company that pollutes the air when it
produces its good

the original decision maker. The cost spillover to other people or society

Zoram only looks at its INTERNAL costs the firms ignores the social cost of pollution SO, the firms marginal cost curve is its supply curve When your factor in EXTERNAL costs, Zoram is producing too much
of its product
MCT = MCP + MCS MCP

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! !

The government recognizes this and limits production

MBT

Monday, November 18, 2013

Positive Externalities (aka: spillover benefits) - Situations that result in a BENEFIT for someone other than the
original decision maker.

! ! ! ! !

- The benefits spillover to other people or society - ex) A mom decides to get a flu vaccine for her child - x axis: price/cost
MCT

MBT = MBP + MBS MBP

- Monopolies fair returns: at ATC = D Optimum price/output: AVC = D Profit/ loss from mr and AVC intersection up to D antitrust laws: - laws designed to prevent monopolies and promote competition after civil war, advances in technology and transportation lead to
national markets

Eventually only a few firms began to dominate industries:

Railroads, steels, meatpacking, coal, etc

- Why are monopolies a market failure? monopolies destroy the key ingredient of the free market systems.
competition.

- to fix this MARKET FAILURE the government must get involved - What does the government do? legislative branch: - passed laws designed to stop monopolies - Sherman Act of 1890 Every person who shall monopolize or

conspire to monopolize shall be deemed guilty of a felony

Executive branch - The federal trade commission must approve all corporate mergers - when firms use anti-competitive tactics the department of
justice files suit against them

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Judicial branch - supreme court finds the firm guilty f not guilty and assigns a
punishment

*Memorize what governments can do* The Coase Theorem - Unfair distribution of income/wealth Income Inequality - using average income is not true How does the government measure distribution of income? Measuring Income Distribution - The government divides all income earning families into five equal
groups (quintiiles) from poorest to richest

- Each groups represent 20% of the population - If there was perfect equality then 20% of the families should earn
20% of the income, 40% should earn 40% (and so on)

- The government compares how far the actual distribution is from

perfect distribution then attempts to redistribute money fairly

- The Lorenz Curve as the banana gets skinnier, theres more equality within the
system ! ! ! ! ! ! !

as it gets fatter, theres more inequality !

!
- How is income distributed in the United States The Genie coefficient: lorenz curve in number from 0-1. 0 is
extreme equality, 1 is extreme inequality

- as it gets bigger the banana gets fatter, same vice versa Wellfare provides a safety net for citizens (retirement, unemployment,
workers comp health, etc) BUT what are some possible downsides?

Taxes - Proportional tax: Everyone pays the same number - Progressive (graduated) tax a higher %for those that make more - Regressive Tax "6

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`A higher tax rate on those making less <In each of the above situations, the give step in to allocate resources
efficiently>

FINAL EXAM EXAMPLE lol if only i would totally do this //sighs//

- give 100% on the final exam to whichever class gives me $1000 - everyone in the class will get 100% even if they dont pays - solution? everyone pays a mandatory tax
Economics of Pollution

- Why are public bathrooms so gross? - The tragedy of the commons Goods that are available to everyone (air, oceans, lakes, public there is no monetary incentive to use them efficiently results in high spillover costs (ex: overfishing in the ocean) - Perverse Incentives In 1970, government tried to protect endangered woodpeckers by requiring
land developers to report nests on their land to the EPA restrooms) are often polluted since no one has the incentive to keep them down

- The population of these birds decreased b/c land owners would kill the
birds or else risk lengthy production delays (shoot, shovel, and shut up)

Assume the government wanted to limit a firm from polluting. they tell
them they will inspect them twice and they must reduce pollution by 5%

- amount of pollutants would increase b/c these firms will have the
incentive to polite more prior

- Are there market solutions for the _? Yes - How can markets and self interest help to limit pollution? Government can
sell the right to pollute

companies have the incentive to not pollute to sell the excess polluting
rights to others (Capn trade)

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