Econ 200: Lecture 9 April 28, Learning Catalytics Session: Types of Goods 2. Exam Review

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1 Econ 200: Lecture 9 April 28, Learning Catalytics Session: Types of Goods 2. Exam Review

2 2 Refer to the figure below. The social cost of dry cleaning is higher than the private cost because of air pollution produced by the process. What is the deadweight loss of the externality? P, $ per item S2 = MC social S1 = MC private $7.50 $7.25 $7.15 D D, hundreds of thousands of items/ week

3 3 Refer to the figure below. The social cost of dry cleaning is higher than the private cost because of air pollution produced by the process. What is the deadweight loss? P, $ per item $7.60 $7.50 $7.25 $7.15 S2 = MC social S1 = MC private DWL=0.5($0.35)(150,000)= $26250 D D, hundreds of thousands of items/ week

4 Attributes of Goods and Services 4 We have seen that markets are better at providing the efficient level of some goods and services than others. This is related to some important attributes of the goods and services: whether their consumption is rival and/or excludable. Rivalry: The situation that occurs when one person s consuming a unit of a good means no one else can consume it. Excludability: The situation in which anyone who does not pay for a good cannot consume it.

5 The Four Categories of Goods 5

6 Efficient Provision of the Categories of Goods 6 Markets tend to be good at providing efficient levels of private goods. Why? The person making decisions about how much to purchase tends to be the only one benefiting from the good, so only their preferences matter.

7 Efficient Provision of the Categories of Goods 7 Markets are not so good at providing efficient levels of the other types of goods. Why? People can free-ride on public goods, enjoying the benefits from them without paying for them. People have little incentive to conserve common resources, leading them to be over-consumed (tragedy of the commons). Profit-maximization tends to lead too many people to be excluded from quasi-public goods.

8 Constructing Market Demand Curves Public Goods 8 For a public good add the prices each consumer is willing to pay. Top: Jill is willing to pay $8 per hour for a security guard to provide 10 hours of protection. Middle: Joe is willing to pay $10 for that level of protection. Bottom: P= $18/hour & Q=10 hours will be a point on the demand curve for security guard services.

9 Efficient Production of a Public Good 9 But finding this market demand curve can be difficult; consumers may not have incentives to reveal their willingness to pay for public goods. Cost-benefit analysis can be useful to determine the correct levels of public goods.

10 Efficient Consumption of a Public Resource 10 Common resources tend to be over-consumed. Why? While people cannot be excluded from the resource, their consumption is rival, depleting the resource for other people. This can be thought of as a negative externality. Ideally, we would make people pay for their consumption, as with Pigovian taxes. àwhen this is not possible, the situation is referred to as the Tragedy of the commons, with the common resource being overused.

11 Common Resources: Efficient Level of Consumption 11 The efficient level of use, Q Efficient, is determined by the intersection of the demand curve and S 2. But each individual tree-cutter ignores the external cost, resulting in Q Actual wood being cut. As the quantity is not optimal, there is deadweight loss as a result.

12 A Way Out of the Tragedy of the Commons 12 The source of the tragedy of the commons is the same as the source of negative externalities: lack of clearly defined and enforced property rights. When enforcing property rights is not feasible, though, two types of solutions to the tragedy of the commons are possible: 1. If the geographic area involved is limited and the number of people involved is small, access to the commons can be restricted through community norms and laws. 2. If the geographic area or the number of people involved is large, legal restrictions through taxes, quotas, and tradable permits on access to the commons are required.

13 Can you give an example of the tragedy of the commons? 13

14 14 Can you give an example of the tragedy of the commons? My answers: - Groundwater in Las Vegas, Nevada - Traffic on I-5

15 15 Assume that the market for sriracha sauce can be represented by the following supply and demand equations: P=Q s /10 P=10-Q D /10 The production of each bottle of sriracha sauce creates an external cost of $3 so that the Marginal Social Cost of sriracha production is given by P=3 + Q s /10 P, $ per bottle S2 = MC social S1 = MC private D D, bottles per day Find the Deadweight Loss in this market

16 16 Assume that the market for sriracha sauce can be represented by the following supply and demand equations: P=Q s /10 P=10-Q D /10 The production of each bottle of sriracha sauce creates an external cost of $3 so that the Marginal Social Cost of sriracha production is given by P=3 + Q s /10 Find the Deadweight Loss in this market P, $ per item $8 $6.50 $ S2 = MC social S1 = MC private Qe=35 (Solve 3 + Q s /10 = 10-Q D /10) Qm = 50 (Solve Q s /10 = 10-Q D /10) Pm=$5 DWL = $22.50 $3 (amount of negative externality) D D, hundreds o thousands of week

17 Midterm Exam Guidelines No graphing calculators or iphones No hats No bathroom breaks except in emergencies No papers of any kind leave them at home or put them in a bag under your desk No talking, even after your exam is turned in Please arrive and be seated at least 5 minutes early 17

18 Midterm Exam Guidelines Exam covers chapter 1-6 (No Ch 9 / Trade) Please answer questions clearly, neatly, and show all work E.g. DWL= ½ ( )($4-$2) = $100 NOT DWL=$100!!!! Answers will be graded for correctness and understanding of concepts Monday Office Hours 2:30-4 (savery 339) 18

19 19 Midterm Exam Extra Problems In myeconlab: Go to Chapter Resources (left side nav bar) for additional problems, chapter homework, and quizzes All back of the book questions are here as well as a 10 question quiz for each section of the book.

20 Outline of Topics (Note: Exclusion from this list does not mean exclusion from the test) Ch 1: How to graph/slope of the line Calculating percent change What does marginal mean? Ch 2: Comparative advantage and opportunity cost Specialization and gains from trade 20

21 Outline of Topics Ch 3: Demand curves/law of demand Shift in demand Supply curves/law of supply Market equilibrium Shift in supply Changes in equilibrium 21

22 Outline of Topics Ch 6: Elasticity of demand & midpoint theorem Inelastic vs elastic demand (technical definition and intuitive meaning) Demand elasticity and revenue Elasticity of supply & definitions Ch 4: Surplus and efficiency (CS and PS) Price floors and price ceilings how do they work? Graphs, examples, welfare effects (DWL) Taxes - ditto 22

23 Outline of Topics Ch 5: More comparative advantage and calculating gains from trade Trade restrictions Graphs, restrictions, welfare effects 23