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Micro 2 summary Lecture 1 tm 6

Microeconomics 2 for ECO: Welfare Economics (Tilburg University)

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Micro 2

Lecture 1
- More profit can be made by replacing expensive labor for cheap labor, and by replacing labor by
machines = reallocation of resources

-
- In an efficient market, all changes in consumption/production would make it worse for someone
- Dimensions of efficiency
o Exchange efficiency
o Production efficiency
o Product mix efficiency
- Edgeworth box

o
- An allocation is Pareto optimal if it is not possible to make one individual strictly better off
without making any other individual worse off
- MRSbwAdam = MRSbwEve; You trade up to the point where your valuation of bread (in terms of
water) is exactly equal to the other person’s valuation of bread

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- Marginal Rate of Transformation
o MRTbw = Marginal rate of transformation of bread for water
o MRTbw = MCb /MCw

Lecture 2 & 3
- External effect of your decision on others that is not reflected in your costs (producer) / price
(consumer)
- Two sources of negative externalities
o Common property: resource that anyone can access → tragedy of the commons
 Fish stock depletion
o Undesirable by-product of production or consumption
 Water and air pollution
- Negative production externality: social MC>private MC
- Positive production externality: reverse
- Negative consumption externality: social MB
- Positive consumption eternality: reverse
- Coase theorem: Externalities only solved through market when
o Property rights are well-defined and enforceable
o Bargaining costless, otherwise parties may not find it worthwhile to negotiate
o Parties know costs, benefits of reducing externality

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- Mpc = marginal private cost

- Mpb = marginal private benefit

- A Pigovian tax on output
o on each unit of polluter’s output
o Exactly right tax, with efficient allocation, is called Pigovian

-
- Cap-and-trade
o Government specifies the cap: total pollution allowed
o Distributes fixed number of ‘pollution permits’
o Trading of allowances among firms
- Cap-and-trade involves relatively great administrative challenges: setting up market for trading
of permits (compared to emission fee)

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- Command-and-Control
o Technology standard
o Performance standard

-
- positional externality example: ‘Status’ symbols: your win is my loss

Lecture 4
- People may do little for things that have a private cost and a public benefit
- Free rider problem: occurs when those who benefit from goods do not pay for them, which
results in under-provision of those goods
- Public goods
o Consumption of something of which the benefits are shared with others: Non-
excludable
o Everyone can use it at zero marginal cost: Non-rival

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- Pareto efficiency for public goods

o MRSfa Adam + MRSfa Eve = MC
- Some private provision of public goods when:
o Individual willingness to pay exceeds marginal costs at Q>0
o Altruism
o Warm glow: it feels good to do good
- Median voter theorem: the outcome of the majority reflects the preferences of the median
voter
- Three challenges for public provision
o Crowding out of private provision
o Measuring costs and benefits of public good
o Measuring preferences for public good
- Crowding out: public and private contributions are substitutes
- Crowding in: public and private contributions are complements

Lecture 5
- internalities: cost we impose on ourselves, as a result of which we take actions that are not in
our own best interest
- We allow that consumers only serve their own best interest in some contexts and not in others:
a deal can make them worse off
o Decisions may be inconsistent across contexts

-
- Present bias: focus on the here and now
o With delayed benefits, the context really matters
o In some contexts, we don’t study, even though we’d like to study
o Present bias is never an issue for products with immediate costs and benefits
o Studying and others products with delayed benefits have been called ‘investment goods’

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- What governments can do

o Decide for us: Mandate; No alcohol under 18
o Give a Nudge; Warning on cigarette packs

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- Nudge: “Any aspect of the choice architecture that alters people’s behavior in a predictable way
without forbidding any options or significantly changing their economic incentives”

Lecture 6
- Why do we not have markets everywhere?
o We do not want them
o They do not come about by themselves
o The conditions may not be satisfied
o Furthermore we don’t like market outcomes: they produce too unequal outcomes

- If we do not want markets:

o The government bans them
- If markets do not arise spontaneously
o The government may create them
o Government may step in its place: government production
- If markets fail, that is, if they do not produce Pareto efficient outcomes:
o The government structures and regulates markets
o Or the government may act as a producer itself
- To make market outcomes less unequal
o The government regulates markets and redistributes money

- Banning markets: Drugs market; baby market

- Creating markets: The EU Emissions Trading Market (ETS); The mobile communications market
- Regulating markets: two types
o Entry regulation: Which firms and how many firms are allowed to be active on market?
o Conduct regulation: General rules; Market specific rules

- Two theories of government intervention

o The public interest theory
o The private interest theory

- We say that there is imperfect competition if firms have market power

- Market power is the power of a firm to profitably set its price above its marginal cost:
o Lerner index:

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