IB Economics Unit 2 Microeconomics

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IB Economics - Unit 2 Microeconomics

• Market Failure
• IB Course Companion ch 13
• Baumol Blinder ch 15

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Market Failure Defined

• IB Course Companion p 134
• Pareto Optimality exists whenever markets are in
  equilibrium with no external influences or
  effects.
• Community Surplus is maximized under P.O.
• Market failure exists whenever community surplus
  (producer consumer surplus) fails to be
  maximized.

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Another View of Market Failure

• Baumol Blinder (p. 312)
• Markets have several problems that can lead to
  failure
• Severe bus cycle
• Income inequality
• Monopoly inefficient allocation of resources
• Public goods underprovided
• Present vs future allocation of resources
• Public personal services can become expensive,
  requiring government intervention

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Key Terms

• Pareto Optimality
• Community Surplus
• Marginal Social Cost
• Marginal Social Benefit
• Public Good
• Merit Good
• Demerit Good

• Externalities
• Positive / Negative
• Moral Hazard
• Marginal Social Cost / beneift
• Marginal Private Cost / benefit

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Types of Market Failure

• IB Course companion, pp 135 - 145
• Imperfect competition (monopoly) 135
• Lack of Public goods (136)
• Under-supply of merit goods (137)
• Oversupply of demerit goods (137)
• Externalities (138 - 145)

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Imperfect Competition

• Whenever one firm acts with monopoly power it
  does two things
• It raises prices as high as possible
• It restricts production
• Both actions increase revenute profits for the
  firm, but lead to market failure by
• Reducing Community Surplus (see graph p. 135)
• Reducing total production so that all those who
  want and should be able to afford the good cannot
  do so.

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Lack of Public Goods - 1

• Public Goods Goods which are beneficial to
  society but which would not be provided in a
  market.
• Non-excludable I cant prevent anyone from
  enjoying benefits of them (think national
  defense)
• Non-rivalrous One person consuming the good
  doesnt prevent anyone else from consuming it
  also (think flood control)

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Lack of Public Goods 2

• Governments try to solve this problem by
• Providing the public goods themselves
• Subsidizing private firms to provide the good for
  society as a whole.

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Undersupply of Merit Goods

• Merit Goods They are the goods that the
  government thinks provide positive benefits for
  both the people that use them and society as a
  whole, and therefore they think that such goods
  should be consumed to a greater degree.
• Governments attempt to increase the supply, and
  therefore the consumption, of merit goods.
• Examples eduation, health care, sports
  facilities the opera. (p. 136)

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Oversupply of Demerit Goods

• Demerit goods they are the goods that the
  government thinks are bad both for people who
  consume them and for society as a whole,
  therefore the government would like to see them
  consumed to a lesser degree or not at all.
• Examples cigarettes, alcohol, hard drugs and
  child pornography. (p. 137)

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Points to Remember

• All public goods are merit goods.
• Highly desirable merit goods (e.g., education)
  will often be provided at no direct cost to the
  consumer.
• Less desirable merit goods will be subsidized
  less heavily.
• Highly dangerous demerit goods will be outlawed.
• Less dangerous demerit goods will be heavily
  taxed by the government.

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Externalities - 1

• Anytime the production or consumption of a good
  imposes a cost or benefit on a third party an
  externality happens.
• If the externality is a cost, we call it
  negative. (auto production air pollution)
• If the externality is a benefit, we call it
  positive. (Intel in Folsom volunteer programs
  in the Folsom schools)

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Externalities 2Four Types
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Externalities 3Social Costs Benefits

• Negative externalities impose an additional cost
  on society known as the marginal private cost.
• Marginal social cost is actually equal to
  marginal private cost plus or minus any
  externalities involved. (p. 138)
• So, too, marginal social benefit is equal to the
  marginal private benefit plus or minus any
  externalities. (p. 138)