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Chapter 1

ECON 1B03 Chapter Notes - Chapter 1: Market Failure, Market Power, Externality

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Hannah Holmes

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Richard Damra Thursday, January 10, 2013
Econ 1B03
Gains from Trade
In a market economy, people engage in trade with each other
Not every family or nation can produce everything it needs effificently
We specialize in tasks we do best and trade with others for the things we need that they can
provide. (division of labour)
In this way, we have gains from trade
Efficiency: we make the best use of our resources (economic decisions)
Equity: Fair distribution of resources (political decisions)
Market failure: Occurs when the market fails to allocate resources efficiently. Government may
Externality: Impact on someone random. (ex: Guy buying tree and their neighbor gets shade).
Impact of one person or firm’s actions on the well-being of a bystander
Market power: ability of a single firm to unduly influence market prices eg. Monopoly.
Some goods just aren’t suited for the market. Eg donor organs
The Economist’s Roles
When economists are trying to explain the world, they are scientists
When economists are trying to change the world, they are policy advisors.
Positive vs Normative Statements
Positive statements: describe the world the way it is. Descriptive analysis
Normative statements: Describes how the world should be. Prescriptive analysis
Why Economists Disagree
They may disagree about the validity of alternative positive theories about how the world works.
They may have different value and, therefore, different normative views about what policy
should try to accomplish
Economic Models
Economists use models for many reasons.
We try to model human behavior so we can make accurate predictions about economic
This involves making assumptions based on theory
We use models to help us explain how the economy works.
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