Draw a graph indicating how negative externalities...

Name: Problem 2, Chapter 4: Economic Issues and Policy (with InfoApps 2-Semester Printed Access Card)
Uploaded: 2020-06-18T18:07:34-08:00
Duration: 3 min 20 s
Channel: Jesse Leija
Description: Draw a graph indicating how negative externalities (spillover costs) would (1) result in a lower price of a good when its production creates the spillovers and (2) cause overallocation of resources. (Hint: Refer to Chapter 3.)

Draw a graph indicating how negative externalities (spillover costs) would (1) result in a lower price of a good when its production creates the spillovers and (2) cause overallocation of resources. (Hint: Refer to Chapter 3.)

Key Concepts

Overallocation of Resources

Because the external costs are not reflected in the market price, resources are overallocated to the production of the good. This results in overproduction relative to the level that would be socially optimal if the full societal costs were considered, leading to a welfare loss commonly referred to as deadweight loss.

Market Equilibrium

Market equilibrium is determined by the intersection of the supply (representing MPC) and demand curves. When firms ignore the external costs, they produce at a level where MPC equals demand, leading to a price that is lower than the socially optimal price, and consequently, a higher quantity than is optimal for society.

Negative Externalities

Negative externalities occur when a production or consumption activity imposes costs on third parties not involved in the transaction. This market failure means that the good’s market price does not reflect the true cost to society, leading to an inefficient allocation of resources.

Marginal Private Cost vs Social Cost

The marginal private cost (MPC) reflects the costs borne by the producer, while the marginal social cost (MSC) includes both the private cost and any external costs imposed on society. In the presence of negative externalities, the MSC is higher than the MPC, meaning that the true cost of production is underrepresented in market transactions.

Transcript

00:01 Should affirm shut down in the short run and when should affirm not shut down in the short run.

00:06 Let's draw two different sets of axes that will illustrate this.

00:10 In general, we have something called the shutdown rule, which is asking, what is the relationship of price to average variable cost? if price is less than average variable cost, not less than or equal to.

00:28 If just if price is less than average variable cost, then the firm will shut down in the short run.

00:36 So let's graph that.

00:39 For one firm, they will have a marginal cost curve that takes the usual j shape.

00:48 They have a downward sloping marginal revenue curve, and let's say their average total cost is up here.

00:57 Their average variable cost on the other hand is down here.

01:09 This is obviously not to scale.

01:12 The fixed cost, the difference between these two curves, by the way, is the fixed cost, and you usually don't see fixed costs that big, but let's just go with it for now.

01:21 So, this firm will be producing at the point where marginal cost equals marginal revenue right there.

01:28 And they are indeed operating at a loss.

01:31 This distance here between marginal revenue and average total cost, that's the amount of loss they have for each product they make.

01:42 But they are still above their variable costs...

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