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Unformatted text preview: Principles of Economics I
Economics 101 Announcements Readings: Chapter 5 Discussion Sections this week Problem Set 7 available on CTools Quiz in discussion section tomorrow and Friday Domestic Trade Policy and the World Price Imposing trade taxes reduce trade Tariffs reduce imports Export taxes reduce exports Alters net demand on the world market Tariffs reduce world demand for the good Export taxes reduce world supply of the good If domestic market is a LARGE portion of the world market, this will affect prices A tariff will lower the world price An export tax will raise the world price Welfare benefits from the change in world prices Tariff allows purchase of imports at lower prices Export tax allows sale of exports at higher prices World market for an import good
P Tariff revenue Net Supply from the rest of the world Pdom = PW1 + t PW0 PW1
Tariff Revenue captured from the rest of the world
Q1 Net Domestic Demand Q0 Domestic Imports Efficiency of Markets Earlier claim: The competitive market delivers efficient outcomes When the price adjusts to clear the market then
1. 2. 3. 4. All units of the good for which MV P are consumed All units of the good for which MC P are supplied Qd = Qs Therefore every unit of the good for which MV > MC is produced and also consumed (i.e. efficient output levels) Efficiency of Markets
1. All buyers and seller in the markets are "price takers" Otherwise demand and supply curves don't make any sense Predicted equilibrium is unlikely to obtain Efficiency of Markets
2. Property rights must be well defined and protected Otherwise it is impossible to motivate people to trade Predicted equilibrium is unlikely to obtain Efficiency of Markets
3. Informational asymmetries do not exist Otherwise risks associated with trading with better informed agents inhibit trade Predicted equilibrium is unlikely to obtain Efficiency of Markets What if
1. 2. 3. Buyers or sellers are not price takers? All property rights are not well assigned or enforced? Informational asymmetries exist? Market outcomes may not be efficient "Market failure" Possibility that other methods of allocating resources will generate more efficient outcomes Market Failure We will try to address these issues when: Buyers or sellers are not price takers; All property rights are not well assigned or enforced We will not have time to examine: effects of informational asymmetries between traders Market Failure: Part 1 Externalities We investigate a particular set of problems that arise when property rights are not well assigned Example: Rights to the air around us are We cannot trade air the market does not exist Consequently, this is a resource that is inefficiently allocated Not well defined Difficult to enforce, even if they were well defined POLLUTION abounds in inefficiently high quantities Example: Market for electricity from coal generators $/kW/h
MCsoc = MC + MD Supply (MC) MCsoc = MVsoc P* Deadweight Loss Marginal Damage from Pollution (MD) Demand (MV) Qeff Q* Q (kW/h) Example: Pollution What's the problem? Transactions involve two parties People other than those two parties are affected by the transaction Interests of those affected by pollution are not represented in the transaction Buyer Seller Seller's decisions do not reflect the full social cost of providing the marginal unit Call the pollution cost an external cost or spillover cost Externalities An external cost (or negative externality or spillover cost) is a cost that accrues to a party not involved in the market transaction An external benefit (or positive externality or spillover benefit) is a benefit that accrues to a party not involved in the market transaction Implications of Externalities The parties transacting do not consider externalities when making their decisions Market prices will not reflect the full social costs or benefits at the margin Inefficient allocation of resources Too much provision of a good that provides an external cost Too little provision of a good that provides an external benefit $/immunization Example: Immunization
Supply (MC) Deadweight Loss MVsoc = MV + MEB Demand (MV) Marginal external benefit (MEB) Q* Qeff Q (people) Another way of looking at the problem Why does the market fail to deliver the efficient outcome? There is a missing market Imagine we could define the following kind of enforceable rights: Imagine these rights could be traded The right to pollute, or the right not to pollute The rights to demand or withhold benefits from immunization Market price of these rights would reflect the value of the externality Example: Pollution Suppose the right not to consume pollution were guaranteed to the general public If production generates pollution, then to sell a unit of the good the producer must Bear production cost; and Buy the right not to consume pollution away from the public The market price of the right not to consume pollution will be the marginal value of that right: i.e. the marginal pollution cost The external cost is "internalized" The producer now faces the full social cost of producing the output. Example: Pollution
$/unit MCprod + P MCprod + MCpollutionpollution right = MCsoc MCproduction MCsoc = MVsoc P* Ppollution right MCpollution MVsoc Q* Qeff Q Example: Pollution Suppose the right to generate pollution were guaranteed to the producer If production generates pollution, then to sell a unit of the good the producer must Bear production cost; and Forgo the opportunity to sell the pollution right to the general public The market price of the right to pollute will be the marginal value of that right: i.e. the marginal pollution cost The external cost is "internalized" The producer now faces the full social cost of producing the output. ...
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