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A graphical representation of all bundles of goods that make an individual equally well off
indifference curve
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What are the two properties of indifference curves?
- consumers prefere higher indifference curves of indifference curves that are farther out
- indifference curves are always downward sloping
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Why are indifference curves always downward sloping?
because that would violate the "more-is-better" assumption
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The additional increment to utility obtained by consuming an additional unit of a good
marginal utility
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A mathematical representation of all the combinations of goods an individual can afford to buy if she spends her entire income
budget constraint
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What is the budget constraint formula?
M=P1X1 + P2 X2
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In the budget constraint formula, what does M represent?
the source of income
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In the budget constraint formula, what does P1 and P2 represent?
prices of two indifferent goods
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In the budget constraint formula, what does X1 and X2 represent?
the two indifferent products
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Define externality.
Whenever the actions of one party make another party worse or better off, yet the firsr party neither bears the costs nor receives the benefits of doing so
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A problem that causes the market economy to deliver an outcome that does not maximize efficency
market failure
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When a firm's production reduces the well being of others who are not compensated by the firm
negative prodction externality
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the direct cost to producers of producing an additional unit of a good
private marginal cost (PMC)
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the private marginal costs to producers + any costs associated with the production of the good that are imposed on others
social marginal cost (SMC)
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Without market failures, describe the relationship of SMC and PMC.
SMC=PMC
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Describe the relationship between SMC, PMC and MD when there are externalities.
SMC=PMC+MD
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What does MD stand for?
marginal damage done to others from each unit of production
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The direct benefit to consumers of consuming an additional unit of a good by the consumer
Private marginal benefit (PMB)
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the private marginal benefit to consumers - any costs associated with the consumption of the good that are imposed on others
Social marginal benefit (SMB)
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When an individual's consumption reduces the well-being of others who are not compensated by the individual
negative consumption externality
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Describe the relationship between SMB, PMB and MD when there is a negative consumption externality.
SMB=PMB-MD
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where production benefits parties other than the producer and yet the producer is not compensated
positive production externaities
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when an individual's consumption increases the well being of others but the individual is not compensated by those others
positive consumption externality
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In the case of a negative consumption externality, describe the curves displayed on a graph.
SMB curve lies below the PMB curve
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In the case of a positive consumption externality, describe the curves on a graph.
SMB curve lies above the PMB curve
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In the case of a negative production externality, describe the curves on a graph.
SMC curve lies above the PMC curve
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In the case of a positive production externality, describe the curves on a graph.
SMC curve lies below the PMC curve
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When either private negotiations or government action lead the price to the party to fully reflect the external costs or benefits of that party's actions
internalizing the externality
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The part theorem where there are well-defined property rights and costless bargaining
Part I Coase Theorem
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The efficent solution to an externality does not depend on which party is assigned the property rights, as long as someone is assigned those rights
Part II Coase Theorem
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Shared ownership of property rights gives each owner power over all the others
holdout problem
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When an investment proposal has a personal cost but a common benefit, individuals will underinvest
free rider problem
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goods that are perfectly non rival in consumption and are non-excludable
pure public goods
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goods that satisfy the two public good conditions to some extent, but not fully
impure public goods
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What is the crowd-out problem?
as the government provides more of a public good, the private sector will provide less
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Explain the warm glow model.
A model of public goods provision in which individuals care about both the total amount of the public good and their particular contributions as well
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Discuss the areas around the budget line.
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 What do points A and B represent?
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