- •Determine the arguments people use to advocate trade restrictions.
- •Describe what happens to the gains from trade when a tax is imposed.
- •The meaning of externality. Describe the types of externalities.
- •Describe why externalities can make market outcomes inefficient. Use the graphs to explain.
- •The types of private solutions to externality. Define the Coase theorem.
- •44. Determine why private solutions to externalities sometimes do not work
- •45. Identify the various government policies aimed at solving the problem of externalities
- •46. Describe the different kinds of goods, and give an example of each
- •47. The importance of free-rider problem. Explain why private markets fail to provide public goods.
- •Explicit Costs
- •Implicit Costs
- •53.Explain the various measures of cost. Give the meaning of average total cost and marginal cost and explain how they are related. Fixed Costs
- •Variable Costs
- •54. Describe the relationship between short-run and long-run costs
- •55. Explain how competitive firms decide when to shut down production temporarily and how competitive firms decide whether to exit and enter a market?
- •56. Explain why some markets have only one seller. Describe how a monopoly determines the quantity to produce and the price to charge.
44. Determine why private solutions to externalities sometimes do not work
Despite the appealing logic of the Coase theorem, private actors on their own often fail to resolve the problems caused by externalities. The Coase theorem applies only when the interested parties have no trouble reaching and enforcing an agreement. In the real world, however, bargaining does not always work, even when a mutually beneficial agreement is possible.
Sometimes the interested parties fail to solve an externality problem because of transaction costs, the costs that parties incur in the process of agreeing to and following through on a bargain. In our example, imagine that Dick and Jane speak different languages so that, to reach an agreement, they will need to hire a translator. If the benefit of solving the barking problem is less than the cost of the translator, Dick and Jane might choose to leave the problem unsolved. In more realistic examples, the transaction costs are the expenses not of translators but of the lawyers required to draft and enforce contracts.
45. Identify the various government policies aimed at solving the problem of externalities
When an externality causes a market to reach an inefficient allocation of resources, the government can respond in one of two ways. Command-and-control policies regulate behavior directly. Market-based policies provide incentives so that private decisionmakers will choose to solve the problem on their own.
REGULATION
The government can remedy an externality by making certain behaviors either required or forbidden. For example, it is a crime to dump poisonous chemicals into the water supply. In this case, the external costs to society far exceed the benefits to the polluter. The government therefore institutes a command-and-control policy that prohibits this act altogether. In the United States, the Environmental Protection Agency (EPA) is the government agency with the task of developing and enforcing regulations aimed at protecting the environment.
PIGOVIAN TAXES AND SUBSIDIES
Instead of regulating behavior in response to an externality, the government can use market-based policies to align private incentives with social efficiency. For instance, as we saw earlier, the government can internalize the externality by taxing activities that have negative externalities and subsidizing activities that have positive externalities. Taxes enacted to correct the effects of negative externalities are called Pigovian taxes, after economist Arthur Pigou (1877-1959), an early advocate of their use.
46. Describe the different kinds of goods, and give an example of each
Is the good excludable? Can people be prevented from using the good? Excludability the property of good whereby a person can be prevented using it
Is the good rival? Does one person's use of the good diminish another person's enjoyment of it? Rivalry the property of a good whereby one person's use diminishes other people's use
Using these two characteristics, goods divided into 4 categories:
Private goods are excludable and rival. Consider an ice-cream cone, for example. An ice-cream cone is excludable because it's possible to prevent someone from eating an ice-cream cone - you just don't give it to him. An ice-cream cone is rival because if one person eats an ice-cream cone, another person cannot eat the same one.
Public goods are neither excludable nor rival. For example, national defense is a public good. Once the country is defended from foreign aggressors, it's impossible to prevent any single person from enjoying the benefit of this defense. Moreover, when one person enjoys the benefit of national defense, he does not reduce the benefit to anyone else.
Common resources are rival but not excludable. For example, fish in the ocean are a rival good: when one person catches fish, there are fewer fish for the next person to catch. Yet these fish are not excludable good because it is difficult to charge fishermen for the fish that they catch.
Natural monopolies are an excludable but not rival. For instance, consider fire protection in a small town. It is easy to exclude people from enjoying this good: the fire department can just let their house burn down. Yet fire protection is not rival. Firefighters spend much of their time waiting for a fire, so protecting an extra house is unlikely to reduce the protection available to others. In other words, once a town has paid for the fire department, the additional cost of protecting one more house is small.