Markets
Competitive markets do a good
job of maximizing surplus –
bringing right buyers and seller
together.
Markets provide information to
buyers and sellers.
- Should I produce this good?
Market Failures
We have assumed that buyers
get the benefits and sellers
incur the costs.
But this is not always the case!
Externalities
Negative externality – when the
costs are borne by people other than
the seller. (Social MC > Private MC)
Positive externality – when the
benefits are enjoyed by people other
than the buyer. (Social MB > Private
MB)
Negative Externalities
Pollution at the Grand Canyon
http://www.cleartheair.org/parks/grandcanyon.vtml
Loud Neighbor, Second Hand Smoke, Passing Gas.
Positive Externalities
Flowers and Lawns
Plastic Surgery
Pest Control
Smell from a Bakery
Asking Questions in Class
Solutions
Pigouvian Taxes – internalize costs or
benefits
Assign Property Rights Coase Theorem: As long as property rights
are well established and transactions costs
are low then the market can reach the
efficient outcome.
ex: trading pollution credits RECLAIM
Network Effects
The value of a good depends on how
many other people use it (positive
externality).
Telephones & Fax Machines
IBM vs. Apple operating systems
e-bay.com
More information on Network Effects
http://oz.stern.nyu.edu/io/network.html
Common Resource
Non-excludable : once available
anyone can consume it.
“Tragedy of the Commons”
-Congestion on Highways
-Jamestown
-Whaling
Common Resource
Solutions through Property Rights
-Congestion on Highways:
HOT Lanes and Variable Priced Tolls
http://www.fhwa.dot.gov/policy/ohpi/
-Jamestown: personal farms
-Whaling: Branding and Barbwire.
We have plenty of cows!
Public Goods
Non-excludable &
Non-rival: one
person’s use
doesn’t diminish
another person’s
use.
Public Goods
Should be produced if
MC < SMB = sum PMB
But if MC < (SMB - my PMB)
then I can pretend that my
PMB =0 and still consume.
“free riders”
Solution: Assign Property Rights
making it excludable.
Alternate Solution: White List
Public Goods
Some numerical examples
Role of Government
Providing Public Goods
Enforcing Property Rights
Ensuring Competitive Markets
Antitrust Laws and the FTC
mergers (vertical and horizontal)
specific practices (tying and
price discrimination)
Regulating Natural Monopolies
Patents and Copyrights
International Trade
Trade Policies
Exchange Rate (Inflation, Money Supply)
International Trade
Typically assume a world price and compare to a
domestic price.
Import if Pw<Pd (no comparative advantage)
Export if Pw>Pd (comparative advantage)
Welfare implications:
society gains from foreign trade
but
but either buyers or sellers do not
Protectionism
Why?
- employment
- unfair practices in foreign countries
- infant industry
(learning curve, economies of scale)
- national security
- bargaining chip / retaliation
How?
-Tariffs (tax on imports)
-Quotas (limit imports)
Exchange Rates are Determined
by Supply and Demand
Euros/$
Exchange
Rate
Supply of $ (People willing
to trade $ for Euros)
Demand for $
(People willing to
trade Euros for $)
Q of dollars
Exchange Rate Risk
When parties trade, they agree to a base currency so
one side is exposed to risk.
Since the exchange rate fluctuates the value of foreign
currency fluctuates.
• If the dollar become stronger then
-you gain if you have to pay in the foreign currency
-you loose if you are receiving foreign currency.
• If the dollar become weaker then
-you loose if you have to pay in the foreign currency
-you gain if you are receiving foreign currency.