ECON 13 Lecture Notes - Lecture 11: Externality, Cost, Social Cost

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7 Dec 2018

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ECON 13 Lecture Notes - Lecture 2: Marginalism, Opportunity Cost, Macroeconomics

ECON 13 Lecture Notes - Lecture 3: Ceteris Paribus, Market Power, Perfect Competition

ECON 13 Lecture Notes - Lecture 11: Externality, Cost, Social Cost

Document Summary

This trade-off arises for all countries, whether high-income or low-income, and whether their economies are market-oriented or command-oriented. Markets are usually a good way to organize economy activity. If there is no market failure, competitive market outcome is efficient, maximizes total surplus. Externality, the uncompensated impact of one person"s actions on the well-being of a bystander. Self-interested buyers and sellers neglect the external costs or benefits of their actions, so the market outcome is not efficient. In presence of externalities, public policy can improve efficiency. An externality occurs when an exchange between a buyer and seller has an impact on a third party who is not part of the exchange. An externality, which is sometimes also called a spillover, can have a negative or a positive impact on the third party. Externalities can be negative or positive, depending on whether impact on bystander is adverse or beneficial. Negative: when 3rd party suffers from the transaction.

Related Questions

Target Statement for Assignment 8

When IT procurement managers do business across a transnational border (or choose which borders to negotiate across) it will be helpful for managers to be aware of what restraints or pressures exist on both sides of the border that will affect the negotiated price of the product or service being acquired. The understanding that Garrettâs entire pricing theory depends on the macroeconomic (and hence also political) environment emerges from considering relations between contract pricing and economic theory, specifically, the âreservation priceâ and âeconomic calculation problemâ.

A fixed-price strategy in Garrettâs account does not mean a price that is fixed legally; it means a price that is determined by negotiation between free parties, such as is described in Ch. 8, pp. 105-106. That is, in Garrettâs pricing theory there is a transaction pricing calculation performed on each side of the transaction. Contract pricing is a decision, about which what matters is not the type of contract but the locus of the decision, that is, who makes the decision, and under what constraints?

Garrettâs Chapter 8 answers: buyer and seller make the decision. In a free-market economy, the pricing decision would be entirely an outcome of their negotiation. In an interventionist economy, the decision is in part an outcome of the buyer-seller negotiation; however, the cost of such interventions as taxes, regulations, currency instability, or contract impairment by monetary inflation, and any price caps or floors are built into or reflected by the sellerâs offering price.

In free market economic planning where there is zero central economic planning, a first approximation to a contract price that is freely set by buyer and seller is the reservation price or âwalk-awayâ price for the buyer. The seller, too, has a âwalk-awayâ price. The negotiation can only occur, resulting in a contract, in the interval between the two. Buyer and seller make a decision through a negotiation based on the sellerâs estimate of the cost of performance and the buyerâs estimate of what price the market, established by other potential sellers, would bear -- both estimates being a function of history.

According to the economic calculation problem described by the economist Ludwig Von Mises, a freely agreed upon price that reflects the combination of the buyerâs and sellerâs needs or desires is based on a calculation of the type that cannot be performed in a condition of central economic planning by a government. Under central economic planning, or socialism, price determination is not a function of trading history, or of the sellers' willingness to sell or the buyers' willingness to buy at a given price, rather it is either an arbitrary or politically-influenced decision. Such central economic planning, Von Mises observes, replaces economic calculation â the statistical aggregate of all individual actions by buyers and sellers who freely set prices by their own transaction pricing calculations.

Under the free market modeled in the theory of Von Mises, contract pricing relies on the absence of such market intervention so that buyer and seller are totally free to set a price that allows a contract to occur in the interval between the seller's and buyer's respective walkaway prices. This decision of both parties to agree on a price in that interval is one component of economic calculation â a component that applies to a single trade or transaction and contributes to the statistical aggregate which, in turn, tends to govern resource allocation so as to bring supply and demand into alignment.

To a lesser extent, contract pricing described by Garrett in Chapter 8 relies largely on the absence of central economic planning. Why? Because when the state intervenes it either substitutes its decision for that of the buyer and seller, or at a minimum imposes price controls that either foster shortages or surpluses or else tend to preclude the contract from ever happening if the controlled price is below the sellerâs cost estimate.

Under contract pricing as described by Garrett, the parties to the contract are still able to perform calculations of reservation (walkaway) prices and determine whether they can do the deal at some price in the interval that does not cause either to walk away. However, in a market that is only partially free, interventions such as regulations, taxes, currency exchange fluctuations, or monetary inflation that increase the sellerâs cost do alter the pricing calculation and tend to narrow the interval within which the buyer and seller can come to agreement. That still-intact possibility of agreeing on a price sensitive to market conditions is the essence of the relationship between the economic theory of Von Mises and the contract pricing theory of Garrett.

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Question 1

Which compensation method helps to explain the large difference between the salaries of top-level managers and mid-level managers in a firm?

	A.	Tournaments
	B.	New blood
	C.	Piece rate
	D.	Backloaded compensation

3 points

Question 2

Please consider the information provided under Question 19 in Chapter 3 (page 54). Based on the stated information, the optimal number of bees kept if the externality is ignored by Yung is 5,000. Is the socially optimal number of bees higher or lower than 5,000?

	A.	We do not have enough information to answer this question
	B.	Same
	C.	Lower
	D.	Higher

3 points

Question 3

Which of the following factors contribute to the existence of firms?

	A.	All of these factors contribute to firm existence
	B.	Risks associated with specialization
	C.	Incomplete contracts
	D.	Willingness of some people to take on risk in exchange for residual income

3 points

Question 4

Public goods are often subject to free-rider problems because these goods are:

	A.	Non-rival and non-excludable
	B.	Rival and non-excludable
	C.	Non-rival and excludable
	D.	Rival and excludable

3 points

Question 5

Which of the following is the most efficient mechanism for allocating scarce goods?

	A.	Government allocation system
	B.	First-come-first-served system
	C.	Market system
	D.	Random allocation system

3 points

Question 6

Many years ago, most of the major Hollywood movie studios also owned chains of local movie theaters across the US. Today, most of the local movie theaters are owned by other companies. What has happened to the degree of integration in the movie industry over time?

	A.	Less horizontally integrated
	B.	Less vertically integrated
	C.	More horizontally integrated
	D.	More vertically integrated

3 points

Question 7

Your firm produces replacement parts for the nuclear submarines operated by the US Navy. Which one of Porter's Five Forces will be most prominent in determining your strategies and profitability?

	A.	Bargaining Power of Suppliers
	B.	Bargaining Power of Customers
	C.	Threat of New Entrants
	D.	Threat of Substitutes

3 points

Question 8

Which of the following statements is NOT true?

	A.	The market mechanism for allocating resources is most efficient due to the incentives it creates.
	B.	Markets are always the most efficient way to allocate goods, even if the market is not perfectly competitive.
	C.	The random allocation mechanism provides no incentives at all.
	D.	The government allocation mechanism provides no incentive for the economy to grow.

3 points

Question 9

Suppose a firm's cost structure exhibits economies of scope. Which of the following actions is compatible with this cost structure?

Diversify into other product lines

Focus on core competencies and reduce production

Focus on core competencies and maintain constant production

Focus on core competencies and expand production

Question 10

Please refer to Table 8.3 on page 132 in the book. Suppose we change the payoffs in the "low price, low price" cell to 0, 25 from 0, 0. Does this change the Nash equilibrium for the game, and is the game still a Prisoner's Dilemma?

	A.	Equilibrium changes, still a Prisoner's Dilemma
	B.	Equilibrium changes, no longer a Prisoner's Dilemma
	C.	Same equilibrium, no longer a Prisoner's Dilemma
	D.	Same equilibrium, still a Prisoner's Dilemma

3 points

Question 11

Which of the following statements about restricting entry to markets is NOT true?

	A.	Brand identity and logos are expensive to establish, and entrants may find it very expensive to establish comparable position in the market.
	B.	Predatory pricing is illegal but very difficult to prove in court
	C.	Branded products tend to have more elastic demand, which makes it more difficult for entrants to charge high prices and they must stay out of the market.
	D.	A low-quality seller cannot effectively use a warranty program to keep other firms out of its market

3 points

Question 12

Your firm earns $2 million per quarter in total revenue, and your accounting profits are $100,000 per quarter. You do not charge the firm for the use of an old building that you own because it is 50 years old and fully depreciated. However, another firm has offered you $200,000 per quarter to use the facility, and this is the market rental rate for similar facilities. In this case, we know that your:

	A.	Opportunity costs are positive and economic profits are negative
	B.	Opportunity costs and economic profits are positive
	C.	Opportunity costs are negative and economic profits are positive
	D.	Opportunity costs and economic profits are negative

3 points

Question 13

Please refer to Question 13 in Chapter 1 (page 17). What is the marginal cost of reducing global warming by 0.017 degrees?

	A.	MC = 60
	B.	MC = 5
	C.	We do not have enough information to answer this question
	D.	MC = 50

3 points

Question 14

In Chapter 6, Boyes focuses on negative externalities such as the various types of pollution. However, as we discussed during our online session, we can also observe positive externalities in which external benefits are generated for people. Which of the following is NOT an example of a positive externality?

	A.	Workers can help one another to "cover the phones" and make sure that someone is always available to help clients
	B.	Workers can provide ideas to one another about how to solve problems
	C.	All of these cases are examples of positive externalities
	D.	Workers can form carpools and use other means to reduce commuting costs

3 points

Question 15

Common property resources are:

	A.	Non-rival and non-excludable
	B.	Non-rival and excludable
	C.	Rival and non-excludable
	D.	Rival and excludable

3 points

Question 16

The free-rider problem arises in markets for common property resources.

	A.	False
	B.	True

3 points

Question 17

Firms that set their product price below the actual cost of production may be engaging in:

	A.	Predatory pricing
	B.	Monopoly pricing
	C.	Moral hazard
	D.	Dollar-cost averaging

3 points

Question 18

Under a cap-and-trade mechanism to control air pollution, what happens to the price of pollution rights if the supply of righs is reduced (i.e., the supply of rights is reduced)?

Increases

Decreases

No change

Question 19

The key method for a manufacturing firm to avoid hold-up problems is to have another source of inputs.

	A.	False
	B.	True

3 points

Question 20

Your firm sells luxury autos, and you have asked the marketing department to develop and stronger brand identity through a new ad campaign. After the campaign has run for 6 months, you hire an economic consultant to study the impact of the campaign on the demand for your autos. The consultant reports that the demand for your cars is now more elastic than it was 6 months ago. Was the new ad campaign successful?