Economics 101: Principles of Economics

1. Economics 101: Principles of Economics • Questions? • Sample questions for review #2 on-line

2. OPEC and CIPEC • OPEC is the Organization of Petroleum Exporting Countries • CIPEC is the French acronym for Int’l Council of Copper Exporting Countries • Why has OPEC been successful in raising its price, but CIPEC has not? • OPEC as a dominant firm Price Oil Market Snon-opec • How much can dominant firm sell? P1 • Now dominant firm sets MR = MC • At Popec, rivals produce Qfringe • Qopec + comp < Q comp + comp Popec • Popec >> Pcomp • Inelastic Snon-opec & inelastic Dmkt inelastic Dopec Popec >> Pcomp • Price controls on gas in 1970s actually reinforced OPEC’s strategy!! • Encouraged domestic consumption • Discouraged domestic production Pcomp MCopec P2 Dmkt MRopec Qopec Qtotal Qfringe Output Qc+c

3. OPEC and CIPEC • CIPEC (Chile, Peru, Zambia, Zaire) • MCCIPEC is not much less than MCnon-cipec • Why has OPEC been successful in raising its price, but CIPEC has not? • CIPEC as a dominant firm Price Copper Market • How much can dominant firm sell? • Now dominant firm sets MR = MC Snon-cipec • At Pcipec, rivals produce Qfringe P1 • Pcipec not much above Pcomp MCcipec • Why can’t CIPEC increase copper prices much? • D for copper is more elastic (aluminum is a good substitute) • Comp’ve supply more elastic than for oil (if P rises, simply go to scrap heap) • Successful cartel needs relatively inelastic D & inelastic Snon-cartel. Not easy Pcipec Pcomp P2 Dmkt MRopec Qtotal Qcipec Qfringe Output Qc+c

4. Social cost Price Supply Demand Qsoc eff Qmkt Quantity Externalities • Supply & Demand typically yield an efficient allocation of resources • Markets are not a panacea -- they can fail to allocate efficiently • Externality exists when a person’s action affects another party, but they neither pay nor receive compensation for that effect. • Negative or positive externality • Social cost includes the private cost (to the firm) & cost to by-standers • Qsocially efficient < Qmarket • How to reach Qefficient ? • Tax the producer so they take costs of their actions into account • Technology spillover • Positive Production externality • Consumption externalities • Positive and negative

5. 10 Principles of Economics • Principle #6: Markets are usually a good way to organize economic activity • Markets can maximize total surplus (total benefit to society from that market) • Prices are signal for both the consumer AND the producer! (invisible hand) • Gov’t intervention can distort prices and thus behavior • Principle #7: Governments can sometimes improve market outcomes • Market Failure = when an uninterrupted market doesn’t allocate resources efficiently (we say there’s a “role for the government”) • Causes of market failures: Externality = uncompensated impact of one agent’s action on welfare of another (+ or - ) Market Power = ability of an economic agent to have great control over price • Governments also intervene with efforts to promote equity

6. Coase Theorem • Coase Theorem: When the parties affected by externalities can negotiate costlessly with one another, an efficient outcome results no matter how the law assigns responsibility for damages. • Coase recognized the reciprocal nature of the problem • Benefit to confectioner of making noise = 40 Cost of the noise to the doctor = 60 • What if confectioner is liable for the noise damage? • Two choices • Outcome • What if the confectioner is not liable for the noise damage? • Causes of failures to resolve externality disputes • Government interventions • Regulate/Limit the behaviour • Pigovian tax to correct (-) externality • Comparison http://www.lib.utexas.edu/maps/europe/austria_pol99.jpg

7. Public Goods • Excludable and rival create 4 categories of goods • Private goods • Public goods • Common resource • Natural monopoly • Let’s look at Non-excludable goods • Public goods and free rider problem (role for the government?) • Cost-benefit analysis of a proposed public project • No price signals as in provision of a private good -- make estimates

8. How Much is a Life Worth? • The rate of disabling injury (fatal & non-fatal) varies a lot Industry Rate of Disabling Injury Construction 210 per 1,000 workers (non-fatal) Manufacturing 360 “ “ Transportation 22 per 100,000 workers (fatal) Construction 33 “ “ Mining 43 “ “ • Hazardous material workers earn 3-4% more, ceteris paribus Workers under lots of physical stress earn 6% more, ceteris paribus • FirmProbability of Fatal InjuryAnnual EarningsEmployment X PX WX 1,000 Y PX + .001WX + $5,000 1,000 Statistical Value of Life = ? • Mandatory Seatbelts in cars costs $300,000 per statistical life saved: Do it. EPA limits on arsenic exposure in glass mfg. costs $142 million psls: Don’t.