Economics Micro & Macro (CliffsAP)

Part III: Microeconomics

■ Provide public goods:Public goods exist because these goods could not be efficiently allocated in a private mar-

ket. A good example is national defense. Excluding non-taxpayers from protection of an invasion may not be the

brightest idea. Aside from it being nearly impossible to do, excluding individuals from national defense would be

too costly and inefficient.

■ Protect against externalities:It is the responsibility of the government to protect society from negative external-

ities. Externalities are negative or positive events that have an impact on individuals outside a transaction. If

pollutants exist in the air or water, the government’s role is to put an end to and clean the pollutants through

taxation and laws.

■ Stabilize growth in the economy:Through fiscal policy, the government examines different phases of the busi-

ness cycle and acts to secure long-term growth in the economy.

Market Failure and Costs

Markets work best when two things occur: First, producers are responsible for all of their costs, and these costs are paid
for by the goods and services firms supply. Second, consumers who pay for these goods and services are the only bene-
ficiaries of the goods and services. If either condition is not met, the result is called market failure. Market failure is
the inability of a market to sufficiently allocate resources that best fit the needs and wants of a society. When there
is market failure, who bears the cost?

■ Marginal private cost:The cost paid by the producer of producing an additional unit of a good or service.

■ Marginal social cost:The cost paid by society to produce an additional unit of a good or service.

■ Marginal private benefit:The benefit or utility a consumer has for a good or service.

Supply and demand depend heavily on costs to the consumer (demand) and costs to the supplier (supply). When the
supplier is responsible for all costs by the pricing of its goods and services, the supply curve represents the marginal
cost of producing additional units. Conversely, when consumers who purchase goods and services become the only
beneficiaries of those goods and services, the demand curve represents the marginal benefit of consumers. Essentially,
producers are responsible for what they produce, and consumers benefit from goods and services they pay for. The
market runs efficiently and equilibrium production takes place at the point where marginal social benefit is equal to
marginal social cost (see Figure 11-1).

Figure 11-1

The graph in Figure 11.1 illustrates the relationship between social costs and benefits when additional units are pro-
duced. The market is at equilibrium when the costs equal the benefits.

Eq Q

Eq P

Marginal Social Cost

Marginal Social Benefit