ECON STUDY GUIDE

James Grossman, 18 November 2012

Market Failure - The market action has not taken into account the outcomes of that action/has not reflected the outcomes in its price. The socially optimal level of production or consumption is not considered by the private parties involved in the action. Public Goods - Goods that are non-exclusive (anyone can use the good) and non-rivalrous (anyone can use it even if another is). It is hard to place an externality value on these goods. Positive Externality - The benefits of production or consumption enjoyed by society, but not by the private parties making the action. Marginal Social Benefit > Marginal Private Benefit. In a diagram, it looks like a new demand curve to the right, where the MSB is to the right of the MPB. Negative Externality - The costs of production or consumption suffered by society, but not by the private parties making the action. Marginal Social Cost > Marginal Private Cost. In a diagram, it looks like a new supply curve to the left, where the MSC is to the left of the MPC. Merit Goods - Goods that carry positive externalities and are decided to be "socially desirable," and usually underprovided by the market. They are underprovided because the benefits enjoyed by the whole (positive externalities) are greater than the benefit enjoyed by the private party managing the action of the good (looks like a new demand curve to the right). Therefore, the private party involved does not have much incentive to produce that good. MSB > MPB and the true market has a higher price and lower quantity. Demerit Goods - Goods that carry negative externalities and are decided to be "socially undesirable, and usually overprovided by the market. They are overprovided because the negative externality it carries, represented as MSC < MPC (looks like a new supply curve to the left), would have a higher price and lower quantity, but it doesn't because there is a market failure, and the true market does not reflect this. Therefore the demerit good has a lower price and higher quantity. Government Responses (ways to encourage/discourage externalities) Merit Goods (Positive Externality) Provide tax cuts to producers and consumers of the good Use positive advertising to promote its benefits Legislation to require specific things (seat belts for positive externality of safety) Provide the good for free Subsidize them so they are produced more and sold at a lower price Mnemonic device - CALFS - Cut, advertise, legislate, free, subsidize

Demerit Goods (Negative Externality) Cap and trade (tradable permits - permits that allow only limited production of the good) Regulation or direct control, a.k.a. legislation Subsidize alternatives to the good Use negative advertising to make known its costs Extension of property rights (people will want to protect their own property) Implement an indirect tax (tax on good/service rather than person or organization) Mnemonic device - PLANET - Permit, legislate, alternative, negative, extend, tax

Examples of Merit Goods - make sure you can elaborate on these Healthy foods Education (be specific... consider talking about a specific discipline) Vaccinations Health services (bs... checkups, preventative surgery, etc.) Use of renewable energy (bs) Carpooling Condoms

Examples of Demerit Goods - make sure you can elaborate on these Cigarettes Alcohol Drugs Guns Junk food CFCs

Miscellaneous Cost-Benefit Analysis - A process by which the costs and benefits of a market action are quantified; that is, how exactly to place a dollar amount on a positive or negative externality. Tragedy of the Commons - An economic problem in which everyone tries to get the greatest benefit from a given resource (almost always a public good). The demand for the resource overwhelms the supply, everyone who consumes an additional unit directly harms others who can no longer enjoy the benefits. Note: One way to think about MSB and MSC in a diagram is that the MSB or MSC curve is where society "wants the curve to be," or where it "should be" when considering externalities. DEED for every problem - Define, example, explanation, diagram. Good luck, Juniors.