---------------------

ACDC Micro Unit 1

For comparative advantage questions, you can cross multiply. Whichever combination produces
the best number (lower for hours questions, higher for total output questions) determines which
country should produce what.

Basically, you find a trade term for one item that is advantageous for both countries (1 x for 2y)
and in the middle of what the two countries can produce on their own.
-----------------

A perverse incentive is an incentive that has an unintended and undesirable result

which is contrary to the interests of the incentive makers. Perverse incentives are a
type of negative unintended consequence or cobra effect.
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ACDC Micro Unit 2

Law of Demand - price and quantity share an inverse relationship, for 3 reasons:
1. Substitution effect
2. Income Effect - can only afford less of the product for a given income.
3. Law of diminishing marginal utility - each additional unit bought gives less
satisfaction.

Market demand curve = sum of Individual demand curves

5 Shifters of demand curve (price doesn’t shift the curve - it is the curve)
For example, if milk causes baldness, it will shift left. If it makes you smart, it will shift
right.
1. Taste and preferences
2. Number of consumers
3. Price of related goods (separated into substitutes and complements, see below)
4. Income (separated into normal goods and inferior goods)
5. Future expectations

Substitutes: if hot dog prices increase, people buy hamburgers instead.

Complements: if hot dog prices increase, people buy less hot dog buns.
Normal goods: if income decreases, demand decreases.
Inferior goods: if income decreases, demand increases (think dollar stores in a
recession).
------------------

Law of Supply - If price goes up, producers will make more of it.

Shifters of the supply curve ( price doesn’t shift the curve- price is the curve)
1. Prices / availability of inputs (resources)
2. Number of sellers
3. Technology
4. Government action: price and subsidies
5. Expectations of future profit

------------------
Double shift rule: if demand and supply shift at the same time, either price or quantity
will be indeterminant (ambiguous); the one that is indeterminate is the one that both
increases and decreases.

Example: if demand increases and supply increases, there will be 2 increases in

quantity. However, the shift in demand will cause a price increase, but the shift in supply
will cause a price decrease. So, price will be indeterminate.
Result: quantity increase, price indeterminate

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Price Ceiling: represented by a horizontal line. If it’s below equilibrium, then it will
cause a shortage, because the quantity demanded will be far greater than the quantity
supplied.

Price Floor: a horizontal line above equilibrium. It will cause a surplus because the
supply will exceed demand.

Subsidies: shift the supply curve to the right

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Elasticity

Elasticity of Demand
Inelastic demand - fairly constant amount regardless of price. e.g. gasoline. The
demand curve is steep (Q doesn’t change much as P changes)
Characteristics of inelastic goods:
 Few substitutes
Necessities
Small portion of income
Inelastic: Elasticity coefficient < 1
Elasticity Coefficient = % change in quantity/ % change in price
This Coefficient is always a negative number, but we usually just use
the absolute value.
Keep in mind that there is a midpoint method for calculating change
in quantity or price. Formula is: change / average of old and new
amounts

Elastic demand - quantity is sensitive to a change in price.

Characteristics of elastic goods:
Many substitutes
Luxuries
Large portion of income
Elastic: Elasticity coefficient > 1

Perfectly inelastic: vertical demand curve and coefficient of 0

Relatively inelastic: steep demand curve and coefficient < 1
Unit Elastic: 45 degree demand curve and coefficient = 1
Relatively Elastic: gentle demand curve and coefficient > 1
Perfectly elastic: horizontal demand curve and coefficient= ∞

Example of inelastic good: insulin injections (quantity demanded doesn’t change with
price)

--------------

Be sure to look at Essentials of Economics textbook pages 92-97 for a thorough

explanation. A linear demand curve is elastic, unit elastic, and inelastic at different
points on the curve.

---------------
Total Revenue Test For Elasticity

Total Revenue = P x Q

For inelastic goods, like gasoline, total revenue will increase if price goes up.
This is because price increases more than quantity decreases.
For elastic goods, total revenue will decrease if price goes up.
This is because quantity decreases more than price increases.

Total revenue can be drawn as a box on the S/D graph.

Keep in mind that the above may be based on a concave (curved) demand curve. For
example, with elastic goods the quantity demanded may increase exponentially with
each decrease in price. With a linear demand curve the elasticity changes along the
curve (see blue text above). A linear demand curve may be less realistic than a concave
one because a drop in price often causes a large increase in quantity sold.

The total revenue test for elasticity only works on the demand curve. It doesn’t
work on the supply curve because an increase in price always creates an increase in
total revenue on the supply curve.

If the demand curve is not straight (changes it’s slope at some point) then there may be
sections that are elastic, inelastic, and unit elastic.

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Cross price elasticity of demand

% change in quantity of product b / % change in price of product a

If the answer is a positive number then the two products are substitutes
If the answer is a negative number then the two products are complements

-------------
Income elasticity of demand

% change in quantity / % change in income

A positive number means that it’s a normal good

A negative number means that it’s an inferior good
---------------
Price elasticity of Supply: same concept as demand

---------------
Welfare Economics
Consumer Surplus = CS = maximum buyer willing to pay - price actually paid

Producer Surplus = PS = price sold for - minimum seller would take

These can be shown on a graph as the triangles above and below the equilibrium point
in the left quadrant of the S/D graph. to calculate the areas of the CS and PS:
area of a triangle = base * height of the triangle / 2

Note: these surpluses are not the exact same thing as surplus supply or shortage.

-------------
Effect of price controls

Dead weight loss = The unfilled area of the CS and PS between an artificial price and
the equilibrium price. This creates an inefficient market

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International Trade (minute 20:15 in unit 2 Summary)

This is not a price ceiling. This is buying a product at a cheaper world price.

Pw= World Price

Qdom = Quantity domestically produced

Qe = Quantity equilibrium
Qconsumed = Quantity consumed

Qimported = Qconsumed - Qdom

There is no dead weight loss, but the domestic producers have less producer surplus.
Consumer surplus is very large (consumers win out at expense of domestic producers)

Tariffs:

Pt = Price with Tariff

Pt = Pw + Tariff
Pt is closer to the equilibrium price and results in a smaller Qimported. This causes an
increase in producer surplus but a decrease in consumer surplus (domestic producers
benefit at expense of consumers).

Taxes (square area) and dead weight loss (triangles around the square area) can be
seen in the triangle between Pw and Pt

----------------------
Unit 2 video minute 23:28

Excise tax - levied at time of manufacture, rather than sale

Causes the supply curve to shift left such that the supply price at a given quantity
(equilibrium and also lower quantities) increases by the amount of the tax. However, the
new equilibrium price may increase less than the amount of the tax, because the tax is
shared by the consumer and producer in the final price at the new equilibrium quantity.

Example: original equilibrium price : $3

Excise tax : $2
The supply curve shifts left so that the new price is $4
The consumer pays $4, but the supplier gets $2
There is a dead weight loss area
There is a box which represents the government tax revenue. It is the square area
between $2 and $4, which represents the $2 excise tax ( $2 supplier +$2 tax = $4
consumer price paid). The consumer pays $1 of the tax and producer pays $1
-------------

Tax incidence : who pays for a tax

Basically, consumers pay any tax above the original equilibirum price, and producers
pay tax below original equilibirum price.

Example: If the demand curve has a unit elastic slope (45 degree angle) then the
producers and consumers will pay an equal share of the tax.

------------

Utility maximization for consumer consumption (maximizing satisfaction)

Marginal Utility MU is a number representing the satisfaction received from an
additional good or service.
Marginal Utility per dollar = MU / P = Marginal Utility / Price

Utility maximizing rule: goal is to consume such that the MU /P of product A is always
equal to MU/P of product B.
------------------
Unit 3 Costs of Production and Perfect Competition

---------------------
Short Run - at least one resource is fixed (eg pizza oven), number of workers might be
variable
Long Run - all resources are variable

TP : Total Physical Product

MP: Marginal Product

Marginal Product = Change in Total product / Change in Inputs

Average Product = TP / # of workers

The Law of Diminishing marginal returns - as variable resources (workers) are added to
a fixed resources (machinery, etc) the marginal increase in output will eventually fall.

3 stages of marginal returns: increasing , decreasing, negative

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Revenue and Costs

Total Costs = Fixed + Variable Costs

Marginal cost = additional costs of an additional output

AVC = Average variable costs = variable costs/ output

AFC = Average fixed costs = fixed costs / output
ATC = Average total costs = total costs / output

AVC + AFC = ATC

Total Revenue = Price * quantity

Profit = total revenue - Total cost

----------------
Accountants vs Economists:

Accounting profit = total revenue - accounting costs (explicit only)

Economic profit = total revenue - economic costs (explicit and implicit)

Something is implicit when it is implied but not directly stated. Something is explicit
when it is directly stated and leaves no room for uncertainty.

Implicit costs are things like opportunity costs.

Cost and Profit numbers in economics include both accounting and economic costs.
Therefore, the cost of production is partially opportunity costs.

Example: a company might break even economically at $10 for their product, but they
might make accounting profit. $8 might be their accounting costs and their implicit
opportunity costs might be $2 (their best alternative could have earned them $2, like
sticking the money in a bank).

Profit Maximizing Rule: (which is also the loss minimizing rule)

A firm should always produce where,

MR = MC

Marginal revenue = Marginal Cost

---------------

4 market structures

Perfect competition
Monopolist competition
Oligopoly
Monopoly

----------------------
Perfect competition (The others will be discussed later)
- many small firms. Identical products. (eg Corn). Low barrier to entry, firms are price
takers (they pay the going rate for the product)

Shutdown Rule:

If Price < AVC, then shutdown, regardless if MR = MC

If Price = AVC < ATC, continue to produce because even after a shutdown there would
be fixed costs. It’s better to continue production and hold onto workers and market
share if total loss is equal whether you shut down or not.

If fixed costs go up then ATC foes up. But MC stays the same, so quantity produced will
not change. MC = MR still applies.

Remember “Mister Darp”

MR = D = AR = P

Marginal Revenue = Demand = Average Revenue = Price

-----------------

Per unit tax - affects variable costs. WILL affect quantity produced.
Lump sum tax - only affects fixed costs. WON’T affect quantity produced.

--------------

In the Long Run:

-Firms will enter if they are profiting.
-Firms will leave if there is a loss.
-So, in perfect competition, no firms will make economic profit.
No economic profit = normal profit.
-In long run equilibrium, a perfectly competitive firm is extremely efficient.

Prices in the long run:

Long run prices will be at MR = D = AR = P. If demand curve shifts right, price will
increase and firms will profit, this is short run equilibrium. More firms will enter the
market, shifting the supply curve right. This will drop the price back to where MR = D =
AR = P. This is now the long run equilibrium again.

Constant cost industry - New firms entering the market does not increase the costs for
the firms already there. Each firm will, over time, produce the same quantity at the same
price (all other things being equal).

Increasing cost industry - New firms entering the market increases costs for firms
already there.

Vast majority of the time, questions will relate to a constant cost industry.

-------------

Productive Efficiency - producing at the lowest possible cost. This would be at the
lowest point on the ATC line.
Allocative (Socially Optimal) Efficiency - producing at the amount society wants. This
would be where price = marginal cost.

In the long run, a perfectly competitive firm is producing at both of the above 2
efficiencies at the same time.

----------------------
UNIT 4 Imperfect Competition

Monopolies (imperfect market)

Demand and marginal revenue for all price makers looks like a v sign gang symbol with
the fingers pointing down, because MR curve (Marginal Revenue) is less than the
demand curve. This is because by lowering the price, you lose the revenue you would
have gotten for the higher price.

Total revenue is at its peak when MR equals 0 (an additional unit would be bring
negative MR). But this doesn’t say anything about MC (marginal cost). MR might be at
its peak, but if MC is higher than MR then the additional cost would be more than the
additional revenue.

Therefore, a firm should produce where MR (marginal revenue) equals MC (marginal

cost):

Quantity produced is where MR = MC (where the two curves cross)

But the price charged will be the demand price at that quantity (look where that quantity
meets the demand curve)

Price charged = price where quantity lands on demand curve

TR = Total Revenue = quantity x price (where quantity meets the demand curve)
TC = Total Cost = quantity x price (where quantity meets the ATC curve)

TR - TC = Total Profit or loss

Two ways to determine profit or loss per unit:

Price charged - ATC = profit or loss per unit
Total Profit / quantity = profit or loss per unit

Note: some tests will show a horizontal line that is labelled “MC = ATC”. Still solve the
problem the same way; the line represents both MC and ATC.

Demand = AR (Average revenue) , which is used on some graphs.

In a monopoly, profit will continue in the long run (unlike in perfectly competitive market
where other firms will compete on price in the long run)

----------------
Elastic and Inelastic range of the demand (as it relates to the Total Revenue Test):

The elastic range of the demand is to the left of where MR = 0

The inelastic range of the demand is to the right of where MR=0
To remember, it’s alphabetical: Elastic on the left, Inelastic on the right.

REFRESHER
Total Revenue = P x Q
Total Revenue Test: (covered in Unit 2 Above)
For inelastic goods, like gasoline, total revenue will increase if price goes up.
This is because price increases more than quantity decreases.
For elastic goods, total revenue will decrease if price goes up.
This is because quantity decreases more than price increases.

Remember, inelastic means that demand doesn’t vary much with price, such as
gasoline or housing. Elastic means that demand changes a lot with price, such as luxury
items. Elasticity is covered in Unit 2
-----------------

Monopolies are inefficient because:

1. Charge a higher price
2. Don’t produce enough - not allocatively efficient (for society)
3. Produce at higher costs - not productively efficient

Keep in mind that productive efficiency in microeconomics as it relates to a single firm is

when it is producing at the lowest ATC (technically in the long run). Allocative efficiency
is when a firm is producing where MC = Price. Also see end of Unit 3, above.

See graphs in video at 12:13. In a perfect competition, MC curve = Supply curve

-----------------
Natural monopolies - eg. Electric company, Fire department.
It is natural for only one firm to exist because they can produce at the lowest cost.

Due to economies of scale, doesn’t make sense for small firms to enter market.

How to spot on a graph: if the ATC is still falling where MC = demand (the socially or
allocatively efficient quantity), then it’s likely a natural monopoly.

Ways government regulates monopolies to avoid dead weight loss:

1. Socially optimal price, where P = MC on demand curve (allocative efficiency). This
may lead to a loss if it’s below ATC, so the government may give a subsidy.

2. Fair return price (break even price) , where P = ATC on demand curve (normal profit)

------------
Price Discrimination
Selling the same product to different buyers at different prices.
Examples: adult vs child movie tickets, coupons, plane tickets
Requirements
1. Can’t be a price taker, must be a price maker
2. Must be able to segregate the market
3. Consumers can’t resell the product

In a perfectly price discriminating monopoly, the MR curve = Demand Curve, because

the firm can charge different prices to different people. The firm would still produce at
MR = MC, but the price would be a range, not one price.

There is no deadweight loss, as the firm is able to produce at the socially optimal
quantity. There is no consumer surplus, because the firm has converted it to profit (the
profit area includes all price points left of the lowest price and above ATC).

Most of the time, test questions will NOT be a price discriminating monopoly.
------------

Monopolistic Competition

-Relatively large number of sellers with a slightly different product (like fast food). A
perfect competition would be the same product (like corn).
-Some control over price
-low barrier to entry
-a lot of non-price advertising

In the short run, the graph looks the same as a monopoly.

In the long run, competitors will enter so the demand will decrease (shift left) for the
firm’s graph. A firm in long run equilibrium: Quantity where MR = MC, Price = ATC

They are not allocatively efficient because Price does not equal MC
Not productively efficient because not producing at minimum ATC
There is excess capacity because they are maximizing profit.
The excess capacity = [Quantity where ATC is lowest] - [Quantity LR where MR is MC]

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Oligopolies

- A few large producers (less than 10)

- high barrier to entry
-identical or differentiated products
- price makers
- mutual interdependence. Strategic pricing (they worry about their competitors
decisions)

Examples: OPEC, cell phone service, cars

Game theory:
Dominant Strategy - if one choice is better in both scenarios, no matter what the
competitor does. A firm may not have a dominant strategy.
Nash Equilbirum - the outcome that will occur when both firms act simultaneously and
have no incentive to change. It assumes that both firms know the other’s options and
what they are likely to do. If Firm 1 has a dominant strategy, then firm 2 can choose the
best option based on Firm 1’s obvious choice.

In the video, the dollar values shown are their revenue, not the price the firm would
charge. This is why the dollar figures don’t always seem “low”, because by going low
they earn the revenue shown which might be higher than if they go “high”.
---------

3 types of Oligopolies:
1. Price leadership (no graph)
2. Colluding
3. Non-colluding

Price leadership - one dominant firm initiates price changes and the others follow

Colluding - called a “cartel”.

Prices and quantities are agreed on.
Similar price and demand structures.
Ability to punish cheaters.
Together they act as a monopoly.
The graph is same as a monopoly, and they share the profit.

Non-colluding Oligopoly
Kinked demand curve
Two ways that firms usually react to competitors price change:
1. Match price. If one firm lowers the price, then the other firm lowers their price,
causing inelastic demand (steep demand curve). Neither firm gains huge
amounts of customers.
 2. Ignore price. If one firm raises the price, the other can stay the same, causing
elastic demand above/left of the kink. (very sensitive to price change because
the firm with the higher price will sell far less quantity at the higher price point on
the demand curve)

The result is a kinked demand curve. In other words, lowering the price doesn’t
create as big a change in the quantity sold, because the other firm is matching the price;
thus that side of the graph is more inelastic. If a firm raises the price, they get far LESS
customers; so that side of the graph is elastic (price change causes a big change in
quantity sold).

The graph of a non colluding oligopoly:

MC might look normal

MR will have a shallow slope until it reaches the quantity of the kink, then it will take a
steeper slope after a vertical drop. This is because the slope of the MR is somewhat
parallel to demand (elastic left of the kink, inelastic right of the kink)

Here’s a chart with the 4 types of Market Structures:

--------------------

Unit 5 - The Resource Market

The resource market is also called the factor market. It’s the stuff used to make other
stuff.

“resource” = “factors of production” = “inputs”

The Resource market has only 2 types of markets:

Perfect Competition
Monopsony

These markets are for hiring resources of land, labor, and capital
This unit will focus on labor, but the concepts also apply to land and capital
Entrepreneurship seems to be excluded as a market, but it’s still an input.
------------
Perfectly competitive labor market
- assumes many small firms hiring workers. No one firm large enough to manipulate the
market.
-workers have identical skills.
-wage is constant
-workers are wage takers

Demand and Supply for Resources

-Firms represent the demand curve - when the price of labor (wages goes down,
quantity demanded increases.
-Labor (or Land, Capital) represents the supply curve - when the price of labor
(wages) go up, quantity supplied increases.

--------------
3 Shifters of Resource Demand

1. Change in demand for the final product - Derived Demand

e.g. Higher demand for Pizza causes higher demand for pizza workers or ovens. Keep
in mind that this isn’t the same as complementary products (cereal and milk).

2. Change in Productivity of the Resource - due to technological advances. For

example, Silicon demand increased after the 1950s.

3. Changes in Prices of other Resources - the other resources could be substitutes or

complements.
e.g. If brick prices go up, the demand for wood will go up as builders look for cheaper
substitutes. This would be a substitute.
e.g. If price of nails goes up, the demand for nails will go down. These are
complementary resources.

------------
3 Shifters of Resource Supply

1. Number of Qualified workers

2. Government regulation/ licensing

e.g. If government required cooks to have a college degree, the supply of cooks would
fall.
3. Personal values regarding work and leisure
e.g. After WWII women entered the workforce which increased the labor supply.
------------
Minimum Wage
- this is a wage floor. Same as a price floor.
- Price floors cause disequilibrium as quantity supplied exceeds quantity demanded.
There will be a surplus of workers.

------------

MRC - Marginal Resource Cost - The cost of hiring an additional resource (worker).

In a perfectly competitive labor market, the wage = MRC

Marginal Resource Cost = change in total cost / change in inputs

-----------

MP - Marginal Product - the additional units (productivity) generated by an additional

worker.

MRP - Marginal Revenue Product - the additional revenue generated by an additional

worker (resource).

https://www.investopedia.com/exam-guide/cfa-level-1/macroeconomics/marginal-
product-revenue.asp

-----------

In a perfectly competitive market,

MRP = MP * price

Another formula:

MRP = Change in total revenue / change in inputs

------------

Continue to hire until:

MRC = MRP
On a firm’s resource graph, the MRC will be a horizontal line, because the price is
constant and set by the perfectly competitive market at a certain wage. The MRP line
will be sloped or curved (generally downward, as each additional worker generates less
MRP). The firm should produce where the two lines intersect.

In the video at 13:20 there is practice with these graphs.

----------

Labor Market Imperfections

-insufficient/misleading job information. Prevents workers from seeking better
employment. Workers don’t know what they should be paid. Some workers don’t know
the equilibrium wage.
-Geographic immobility. People can’t move or too poor to move. Therefore they accept
a lower wage.
-Unions. Workers collude to raise wages above the equilibrium.
-Wage discrimination. Paying people differently for same job based on their race or sex
(illegal).

-----------
Imperfect competition: Monopsony
-One firm hiring workers
The firm is large enough to manipulate the market.
-Workers are relatively immobile
-Firm is wage maker
To hire more workers, the firm must raise wages (in general, for everyone)
Examples: central american sweat shops, small town with car factory, NCAA

To hire another worker, the MRC will be the wage of the new worker plus the amount of
the wage increase for the previous workers.

The Monopsony graph looks like an upside down monopoly graph (V shape).
-Demand for labor slopes down and is equal to the MRP
-Supply of labor slopes up
-MRC slopes up (above the Supply of labor forming a V)
-Workers are hired (quantity) where MRP=MRC
-Workers are paid where Supply of labor meets quantity (because it’s an imperfect
market, it’s below the equilibrium)
For these graphs, you usually only need to know the wage and quantity of workers to be
hired; don’t need to know profit. Note that you pay workers where Quantity (N) meets
Supply of workers (S), although the quantity hired is where MRC = MRP. The MRC line
is above the supply line, because each new worker costs more and more MRC because
you have to raise the wages of all the previous workers. For example, a wage increase
of 50 cents from 1 worker to 2 workers (2 workers get paid more = $1 MRC) has a lower
MRC than from 9 to 10 workers (10 workers get paid more = $5 MRC)

-------------

Combining Resources

Least cost rule: MPx / Px = MPy / Py

(MP is marginal product and P is price)

Basically, you will look at the marginal product per dollar spent ( MP/ P ) for resource
one and resource 2 at each quantity. Then you will buy each resource to maximize
MP/P . For example, 2 robots and 3 workers.
20:53 in video

Profit maximizing rule for combining resources

MRPx/MRCx = MRPy/MRCy

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Unit 6: Market Failure
Market Failure - a situation in which the free market fails to satisfy society’s wants.
Private markets fail to allocate resources efficiently.

What happens? Government steps in to satisfy society’s wants. But needs to be careful
not to create perverse incentives.

Types of market failures:

1. Public Goods
2. Externalities
3. Monopolies
4. Extreme income inequality
---------------
Public Sector - government services, such as roads, parks, public schools
Private Sector - profit seeking businesses

Why must the government provide public goods and service? Because for certain
things, it’s impractical for companies to make any money from it (ie street lights, military,
etc). This is due to the Free Rider problem: when individuals benefit without actually
paying.

Free Riders prevent firms from making a profit. If left to the free market, essential
services would be underproduced. To solve the problem, the government can:
1. find ways to punish free riders.
2. pay or subsidize services with tax dollars. (Republicans tend to be against this)

True public goods:

1. Non-exclusion (don’t exclude people who don’t pay from benefiting. e.g. national
military defense)
2. Shared consumption / non rivalry (one’s person’s consumption doesn’t reduce the
usefulness to others. e.g. city park)

Education and Roads are not a true public good because people can be excluded from
use (tolls and tuition).

-----------------

Governments use supply and demand to determine how much public goods to produce.
Demand for public goods - the marginal social benefit of the good is its usefulness
to society and is determined by citizens’ willingness to pay.

Supply of public goods - the marginal social cost of providing each additional
quantity.

Produce where MSB = MSC

MSB would be determined by adding together everyone’s amount of more taxes they
are willing to pay, for another one of the public good.
MSC is generally determined by the actual dollar cost of the public good (e.g. a park).

----------------
Market Failure #2: Externalities
- a third person side effect.
- there are external benefits or costs to someone other than the original decision maker.

Example: cigarette smoke. Free market assumes that the costs are fully paid by the
purchaser. But all the health effects are not considered by the market (cancer, butts,
second hand smoke, etc)

The government steps in with regulation.

In the example of cigarettes, there would be higher taxes on cigarettes in order to

reduce consumption.

Negative externality (aka “Spillover Cost”)

e.g. factory pollution or cigarettes
Let’s say Zoram is a chemical company. They only look at their internal costs. Their
marginal cost curve is their supply surve.
They don’t look at the external costs of polluting the local river. When you look at the
external costs, they are producing too much.
The government would step in to limit their production.

The graph of a negative externality

- The marginal social cost curve (MSC) is in a left-shifted position parallel to the
marginal private cost (private supply curve). The equilibrium point of the MSC and MSB
(marginal social benefit / demand) will be at a lower quantity.
At quantity Q1 (in the video referred to as QFM - quantity free market) , the difference in
cost between MPC and MSC is the negative externality (market by the double arrow).
This is higher than the MSB, therefore production should be reduced to Q opt and P opt.
To get there, government can do a per unit tax in the amount of the externality (for
example a tax per pack of cigarettes).

When the government taxes in a situation of negative externality, they are getting rid of
a deadweight loss (MSC > MSB). In a normal situation, taxation causes deadweight loss
by raising the price artificially.

--------
Positive Externalities
-e.g. flu vaccine, education, home renovations
-the original demand curve is the MPV (Marginal private benefit)
-the demand curve, not the supply curve, should shift right to create the MSB curve.
This will result in a higher quantity and price. The government can create this shift in
demand by subsidies. The subsidy shifts the demand and eliminates deadweight loss.
For a negative externality:
-Demand = MSB
-Supply = shifts from MPC to MSC

For a positive externality:

-Demand = shifts from MPB to MSB
-Supply = MSC

------------------------
Economics of Pollution

Tragedy of the commons - goods that are available to everyone (air, oceans, lakes,
public bathrooms) are often polluted because there is no incentive to keep them clean.
There is no monetary incentive to use them efficiently (e.g. overfishing small fish).

---------------

Market Failure #3 Monopolies

Anti-trust laws: designed to prevent monopolies and promote competition.

Monopolies produce at lower quantity and a higher price than perfect competition. They
create deadweight loss. Monopolies destroy the key feature of the free market system -
competition.

Government steps in to correct monopoly market failures (by breaking up monopolies,

etc)
Sherman Act of 1890 - anti-monopoly law made it a felony to conspire to monopolize.
-------------

Market Failure #4: Extreme income inequality

Measuring income distribution

-Government divides population into five equal groups, quintiles.
-If there were perfect income equality, then 20% of the families would earn 20% of the
income, 40% of families 40% of income, etc.
-Government compares the actual income equality to ideal equality, and then attempts
to correct it.

Lorenz curve
-Percent of families on the x axis
-Percent of income on the y axis.
-Perfect income equality would show a graph that is a straight diagonal line.
-Income inequality looks like a “banana graph”. Larger the banana, the greater the
inequality.
- Gini coefficient: statistical measurement of the banana graph.
Area A / (Area A + Area B)

The larger the Gini coefficient, the larger the inequality ( maximum is 1)
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Three types of taxes

1. Progressive - takes a larger percent from the higher income earners (U.S. income tax
system)
2. Proportional - same percent from all groups (flat tax).
3. Regressive - takes a larger percent from low income earners than high income
earners. (high income people may still pay more total tax). Example is sales tax, or any
consumption tax.