Lecture 2 - I. The Invisible Hand The goal of today's...

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I. The Invisible Hand The goal of today's lecture is to discuss why the free market may fail, and to discuss the consequences when that happens. To begin, we must consider how the market should function. Adam Smith, who coined the phrase "The Invisible Hand," was the first to notice that a free market of individuals acting in their own self interest leads to a socially-desirable result. Why does this occur: o Demand = Marginal Benefit (MB) o Supply = Marginal Cost (MC) o In equilibrium, P = MB = MC No further beneficial transactions are possible. Normally, a free market brings us to this point. However, there are times when private marginal benefits or costs are not equal to social marginal benefits or costs. When this occurs, the market is unable to allocate resources efficiency. We call this market failure . o The welfare lost because beneficial transactions do not occur is known as deadweight loss . II. Market Failures in Environmental Economics Most of today's lecture dealt with the problems that various types of market failures cause. Of course, most of the course will focus on externalities. However, it is useful to be aware of other types of market failures and how they are relevant for environmental economics. We discussed three in class today. A. Imperfect Information The market depends on perfect information, so that everyone knows all of the options available to them. If this is not possible, people may not make optimal choices. o Note that imperfect information is when different parties have different levels of information. If no one realizes an activity is bad (e.g. Mercury pollution in Onondaga Lake in 1950s), imperfect information is not the problem. It may be that the result is uncertain. Uncertainty is an important
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This note was uploaded on 04/05/2012 for the course ECON 332 taught by Professor Hilarysigman during the Fall '11 term at Rutgers.

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Lecture 2 - I. The Invisible Hand The goal of today's...

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