AS chapter 3 summary

Definitions:
- Productive efficiency: where production takes place using the least amount of scarce resources.
- Economic efficiency: Where both allocative (demand based) productive efficiency are achieved.
- Inefficiency: Any situation where economic efficiency is not achieved.
- Free market mechanism: The system by which the marke forces of demand and supply determine prices and decisions made by consumers and firms. If the free market mechanism fails to achieve economic efficiency there is market failure.
- Information failure: A lack of information resulting in consumers and producers making decisions that do not maximise welfare. (E.G. sigarettes, alcohol) Result of: misleading packaging; persuasive advertising resulting in consumption levels that are not in the best interest of consumers.)
- Asymmetric information: Information not equally shared between two parties. (E.G. Health care, Environment(we know few about pollution), consumer purchases(bad deals))
- Costs and benefits.
There are three types of costs and benefits.

1) Private costs and benefits; these are experienced by the people who are directly involved in the decision to take a particular action. E.G. Take the case of an airport expansion. The private costs are the development costs are paid by the owners of the airport. The private benefits in this case are the revenue received by the airport’s owners and the pleasure that is gained by the additional passengers as a result of being able to travel by air from that extended airport.
- Private costs : The costs incurred by those taking a particular action.
- Private benefits: the benefits directly accruing to those taking a particular action.

2) External costs and external benefits; These are consequence of externalities that arise from a particular action. In the case of the airport expansion, people who live on the flight path of the airport will experience additional noise pollution problems. An external benefit could be if some flights transfer to the expanded airport elsewhere, resulting in less noise pollution for those people who live on the flight path of that airport.
- External costs: The costs that are the consequence of externalities to third parties.
- External benefits: The benefits that accrue as a consequence of externalities to third parties.

3) Social costs and social benefits; these are the total costs and benefits incurred by or accruing to society as a result of a particular action. By definition, the definition, they consist of private costs and benefits and any external costs and benefits that arise.
- Social costs: The total costs of a particular action
- Social benefits: The total benefits of a particular action
- Externalities consisting of:1) Negative externalities, E.G. Air pollution while driving; Illegal dumping of waste; chewing gum and binge drinking (damage or pollution caused by drunk people)
2) Positive externalities, E.G. Inoculations against flu; crossrail ( London’s transport project); Education and training.

- Merit goods: These have more private benefits than their consumers actually realise. (E.G. inoculations. ) Merit goods tends to have positive externalities. Information failure! People don’t know enough about the positive externalities.
- Demerit goods: their consumption is more harmful than is actually realised. (E.G. the excessive consumption of alcohol.) Demerit goods tend to have negative externalities. Information failure! People do not know it’s that harmful.
- Public goods: Goods that are collectively consumed and have the characteristics of non-excludability and non-rivalry. Public goods are goods that most people would like to have but are not affordable in the free market. (E.G. street lightning, Fire service) Public goods have the defining characteristics:
- Non-excludability: Situation existing where individual consumers cannot be excluded from consumption. All people use the service, like police. Not everyone is paying for it indirectly through taxes ( eg foreign visitors) but are receiving the service, this group is freeriding.
- Non-rivalry: Situation existing where consumption by one person does not affect the consumption of all others.
- Quasi-public goods: Goods having some but not all of the characteristics of a public good. (toll-roads)

Government interventions to correct market failure:

- Negative externalities. Government intervenes by charging or giving information. (E.G. the ‘bin it’ campaign for chewing gun) Same for Demerit goods.
- Positive externalities. Government intervenes mostly by giving more information, avoiding information failure. Same for Merit goods.

- Public goods: Goods that are collectively consumed and have the characteristics of non-excludability and non-rivalry. The defining characters of the public goods are:
1) Methods that involve some manipulation of the market mechanism – subsidies, indirect taxation and the provision of information.
2) Non-market methods – direct provision and various forms of regulation and control.
- Direct tax: One that taxes the income of people and firms and that cannot be avoided. (E.G. Income tax)
- Indirect tax: a tax levied on goods and services. (E.G. VAT.. Mostly used to discourage the production and consumption of demerit goods.)
With indirect taxes the government tries to make the polluter pay, this way the external cost is internalized to the producer. This is the polluter pays principle, there are four main problems that occur when applying this principle:
1) There are problems in determining the exact amount of tax, since it is invariably difficult to estimate the cost of the negative externality.
2) Producers may not always pay the full amount of the tax. They might charge the consumer for the tax they have to pay.
3) The PED for most demerit goods tends to be inelastic, so by making the price higher the demand won’t fall that much.
4) Better quality information for consumers might also be used to further reduce consumption.

- Subsidy: A payment, usually from government, to encourage production or consumption. A subsidy is designed to keep prices down while increasing production and consumption. Makes the supply curve move to the right. (EG payments to train-operating companies to operate franchised services, payments to local bus companies to run loss-making services in rural areas, university education )
- Governments do not only correct market failure by using the price mechanism(making demand increase or fall by decreasing or increasing price) but also in the form of regulations, standards and legal controls. E.G. :

1) Environmental – legislation relating to the emission of pollutants into the atmosphere, for the handling, storage and disposal of chemicals, noise levels from pop concert.
2) Transport – legislation governing the compulsory use of seat belts, the construction and use of motor vehicles.
3) Professional – regulations relating to the qualifications of doctors, dentists and nurses, academic qualifications and those for lawyers and accountants.
4) Use of demerit goods – restrictions on the scale of tobacco products and alcohol, various types of dangerous drugs.

- Tradable permits: a permit that allows the owner to emit a certain amount of pollution and that, if unused or only partially used, can be sold to another polluter.
The price of the permits are being determined by the market, the quantity supplied is being set by the government. When there are more firms that want to pollute, demand will increase for the tradable permits which will make the price go up.