Micro

• Dynamic efficiency: Reallocating resources for the best possible use over time
• Market failure arises when a free market fails to deliver efficient allocation of resources, which can lead to social welfare loss
• Reasons for market failure:

  • Overconsumption of demerit goods
  • Underconsumption of merit goods
  • Information failure
  • Missing markets (public goods)
  • Unequal distribution of income and wealth
  • Moral hazard
  • Abuse of monopoly power
• Social cost = Private cost + External cost (SC = PC + EC)
• Social cost: Total cost to society
• Moral hazard: When a party engages in risky behaviour when they know the other party will bear the consequences of their actions
• Private cost: The cost to the individual or firm from the consumption or production of a good
• External cost: The costs incurred and paid for by third parties not involved in the action
• Marginal Social Costs = Marginal Private Costs + Marginal External Costs (MSC = MPC + MEC)
• MSC: The total cost society pays for the production of another unit of a good or service.
• MPC: The change in the producer's total cost due to producing an additional unit of a good or service
• MEC: The change in the cost to third parties due to the production of an additional unit of the good or service
• Social Benefits = Private Benefits + External Benefits (SB = PB + EB)
• Social benefits: The total benefits to society from producing or consuming a good or service
• Private benefit : Benefit gained by the individual or firm from the consumption or production of a good
• External benefit: Benefit to third parties
• If social benefits rise more than private, there are positive externalities
• Marginal Social Benefits = Marginal Private Benefits + Marginal External Benefits (MSB = MPB + MEB)
• MSB: The total benefit to society, from one extra unit of a good
• MPB: The total marginal benefits of every consumer for each quantity of good consumed
• MEB: The additional benefit imposed on third parties by the consumption of an extra unit of a good or service
• Externality: Cost or benefit that is imposed by one or several parties onto a third party who did not agree to incur that cost or benefit
• Positive externality: Where the spill over effect positively impacts and benefit third parties
• Negative externality: Where the spill over effect negatively impacts and impose costs on third parties
• Asymmetric information is when one side of two parties has more knowledge on the product being transacted than the other
• Deadweight welfare loss (DWL) is the cost to society created by market inefficiency, which occurs when supply and demand are out of equilibrium. This is represented as a triangle on the diagram, always pointing to the correct quantity it should be produced or consumed.
• When MSC = MSB, this is the "socially optimal level"
• Positive externalities in consumption exists when MSB > MPB (underconsumed)

  Positive externalities in production exists when MSC < MPC (underproduced)

  * vice versa for negative externalities
• Cost-Benefit Analysis (CBA): Method for assessing the desirability of a project, taking into account the costs and benefits involved by placing monetary values
• Advantages of CBA:

  • All relevant costs and benefits are taken into account
  • When market prices are available, it is easy to give monetary value to each cost and benefit
  • Long term view of the possible consequences of an investment project
• Disadvantages of CBA:

  • Difficult to identify and quantify all relevant costs and benefits over the whole project lifetime
  • Difficult to establish shadow pricing (i.e: placing values on externalities)
• Shadow pricing is a price calculate to more accurately reflect costs and benefits to society of a good where no market price has been set
• short-run: In terms of FOP, labour is the variable FOP and all others are fixed
• Total product: Total number of products made by a firm within a given period, utilising given inputs
• Total product = Average product x labour
• Average product: Output per unit of inputs of variable factors
• Average product = Total product / Labour
• Marginal product: Change in the quantity of total output resulting from the employment of one more worker, holding all the other FOP fixed
• Marginal product = Δ output / Δ input
• Law of diminishing returns states that at a certain point, employing an additional FOP leads to a fall in the marginal product