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 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 RECLAIMRECLAIM

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

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 -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 Q of dollars Euros/$ Exchange Rate Supply of $ (People willing to trade $ for Euros) Demand for $ (People willing to trade Euros for $)

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.