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It’s All About Efficiency…
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And so we begin again… Public policy encourages, discourages, prohibits, or prescribes private actions We base everything on the idea of a perfectly competitive economy Market failures are private choices that violate the perfect economy
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The Benchmark Utility Assumptions of consumption:
More we have, the more utility we have Declining marginal utility Assumptions of production: Buy factor inputs to produce goods for sale Additional unit of output requires same units of input as predecessor Leads to Pareto Efficiency Can’t find an allocation that makes one person better without making at least one worse
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How Do We Measure Changes in Efficiency?
Social Surplus Net benefits from competing in markets
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Caveats General equilibrium model is static rather than dynamic
Can never be complete Assumptions are often violated in reality
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What if the Invisible Hand Gets Confused???
Market failures are private choices that violate the perfect economy Market failures constitute the most commonly advanced rationales for public policy Collective action can allow us to improve efficiency Social surplus is larger under alternative than under market equilibrium
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1) Public Goods Nonrivalrous, nonexcludable, congestable Shoe example
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Public Goods Follow-Up
P example Prisoner’s dilemmas and Nash equilibriums
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2) Externalities Positive or negative Examples?
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3) Natural Monopoly Single firm can produce at lowers cost than any other arrangement If you force it to price efficiently, it leaves. If you allow it to price where it wants, you take a deadweight loss. X-Inefficiency Natural monopoly that doesn’t reach minimum costs
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4) Information Assymetry
Amount of information about the characteristics of a good varies in relevant ways across persons Search v. experience v. post-experience Examples?
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So Those Are the Big Four…
But there are many other limitations of the competitive framework…
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Thin Markets Few buyers or sellers Monopsony Oligarchy
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Preference Problems Endogenous Self-regarding Other-regarding
Process-regarding
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Uncertainty Problems Two-period worlds lead to more complex decisions
Ski example Insurance Risk v. uncertainty Law of large numbers Moral hazards Subjective perception of risk (flood/earthquake)
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Uncertainty Problems Prospect Theory
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Intertemporal Allocation Problems
Contracts in present for future production and delivery What about future generations? How do we know their wants/needs?
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Adjustment Costs Economy is never static like we wish to assume
Epidemic on eggs… Oil embargo and Iranian revolution…
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Macroeconomic Dynamics
Business cycle Fiscal v. monetary policies
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