Microeconomics Study Notes: Welfare, Externalities, Public Goods, Comparative Advantage, Utility, and Production

Chapter 4: Welfare

Consumer and Producer Surplus

Consumer and producer surplus are key concepts in microeconomics used to measure the welfare benefits that buyers and sellers receive from market transactions.

• Consumer Surplus: The difference between what consumers are willing to pay for a good and what they actually pay.

• Producer Surplus: The difference between the price producers receive and the minimum price at which they are willing to sell.

• Economic Efficiency: Achieved when total surplus (consumer + producer) is maximized.

• Deadweight Loss: The loss of total surplus that occurs when the market is not in equilibrium, often due to price controls or taxes.

Example: If a concert ticket is worth $100 to a buyer but sold for $80, the consumer surplus is $20.

Price Controls

Price controls are government-imposed limits on the prices that can be charged in the market.

• Price Floors: Minimum legal price (e.g., minimum wage).

• Price Ceilings: Maximum legal price (e.g., rent control).

Example: A price ceiling below equilibrium creates shortages; a price floor above equilibrium creates surpluses.

Taxes

Taxes affect market outcomes by shifting supply or demand curves and creating deadweight loss.

• Buyer vs. Seller Tax Incidence: The burden of a tax is shared between buyers and sellers depending on elasticity.

• Tax Burden and Elasticity: The more inelastic side of the market bears more of the tax burden.

• Deadweight Loss: Taxes reduce the quantity traded, causing a loss in total surplus.

Formula:

$\text{Deadweight Loss} = \frac{1}{2} \times (\text{Tax per unit}) \times (\text{Reduction in quantity})$

Example: Taxes on cigarettes reduce consumption and create deadweight loss.

Chapter 5: Externalities

Types of Externalities

Externalities are costs or benefits that affect third parties not directly involved in a transaction.

• Positive Externality: Benefits others (e.g., education).

• Negative Externality: Imposes costs (e.g., pollution).

• Private Cost vs. Social Cost: Private cost is borne by the producer; social cost includes externalities.

• Private Benefit vs. Social Benefit: Private benefit is received by the consumer; social benefit includes externalities.

Example: Vaccination provides private health benefits and reduces disease spread (positive externality).

Solutions to Externalities

• Pigovian Taxes: Taxes imposed to correct negative externalities (e.g., carbon tax).

• Pollution Credits: Tradable permits for pollution rights.

• Command and Control: Direct regulation of activities (e.g., emission limits).

• Efficient Pollution Cleanup: Achieved when marginal cost of cleanup equals marginal benefit.

Coase Theorem and Private Negotiation

The Coase Theorem states that if property rights are well-defined and transaction costs are low, private parties can negotiate solutions to externalities without government intervention.

• Example: Neighbors negotiating over noise levels.

Public Goods

Public goods are non-excludable and non-rivalrous, leading to the free-rider problem and inefficiency.

• Examples: National defense, public parks.

• Free-Rider Problem: Individuals benefit without paying, leading to under-provision.

Common Resources

Common resources are rivalrous but non-excludable, often leading to overuse (tragedy of the commons).

• Examples: Fisheries, public grazing land.

Chapter 9: Comparative Advantage

Comparative Advantage

Comparative advantage is the ability to produce a good at a lower opportunity cost than others, forming the basis for trade.

• Example: Country A can produce wheat more efficiently than Country B, while Country B can produce cars more efficiently.

Tariffs

Tariffs are taxes on imported goods, affecting consumer and producer surplus and government revenue.

• Consumer Surplus: Decreases due to higher prices.

• Producer Surplus: Increases for domestic producers.

• Government Revenue: Increases from tariff collection.

Formula:

$\text{Tariff Revenue} = \text{Tariff per unit} \times \text{Quantity imported}$

Quota

Quotas limit the quantity of imports, affecting market outcomes similarly to tariffs.

• Consumer Surplus: Decreases.

• Producer Surplus: Increases.

Chapter 21: Utility

Utility and Marginal Utility

Utility measures satisfaction from consuming goods and services. Marginal utility is the additional satisfaction from consuming one more unit.

• Total Utility: Overall satisfaction from consumption.

• Law of Diminishing Marginal Utility: Marginal utility decreases as more units are consumed.

• Law of Equal Marginal Utilities per Dollar: Consumers allocate spending so that the last dollar spent on each good yields equal marginal utility.

Formula:

$\frac{MU_A}{P_A} = \frac{MU_B}{P_B}$

where $MU$ is marginal utility and $P$ is price.

Income and Substitution Effects

Changes in price affect consumption through the income effect (change in purchasing power) and substitution effect (change in relative attractiveness).

• Giffen Good: A good for which demand increases as price increases, due to strong income effect.

Applications and Behavioral Economics

• Celebrity Endorsements: Influence consumer preferences.

• Network Externalities: Value increases as more people use the good (e.g., social media).

• Fairness: Consumers may pay more for perceived fairness (e.g., anti-price gouging laws).

• Ultimatum Game: Demonstrates fairness and negotiation in economics.

• Behavioral Economics: Studies deviations from rational behavior, such as ignoring sunk costs or being overly optimistic.

Chapter 11: Short-Run Production (Partial)

Short-Run Production

Short-run production focuses on how output changes as variable inputs are added, holding at least one input fixed.

• Marginal Product: Additional output from one more unit of input.

• Average Product: Output per unit of input.

• Law of Diminishing Returns: Marginal product decreases as more units of input are added.

Formula:

$\text{Marginal Product} = \frac{\Delta Q}{\Delta L}$

where $Q$ is output and $L$ is labor.

Short-Run Costs

Short-run costs include fixed, variable, and total costs, as well as average and marginal costs.

• Fixed Costs (FC): Do not vary with output.

• Variable Costs (VC): Change with output.

• Total Costs (TC): $TC = FC + VC$

• Average Fixed Cost (AFC): $AFC = \frac{FC}{Q}$

• Average Variable Cost (AVC): $AVC = \frac{VC}{Q}$

• Average Total Cost (ATC): $ATC = \frac{TC}{Q}$

• Marginal Cost (MC): $MC = \frac{\Delta TC}{\Delta Q}$

Relationship: MC intersects AVC and ATC at their minimum points.

Additional info: Some chapter sections are partial or abbreviated; academic context has been added for completeness.