Glossary
Deadweight loss
A loss of economic efficiency that occurs when the equilibrium for a good or service is not achieved, resulting in a reduction of total surplus (consumer and producer surplus).
Example:
If a government imposes a tax on a product that is too high, it can create deadweight loss by discouraging mutually beneficial transactions that would have otherwise occurred.
Diminishing marginal utility
The principle that as a consumer consumes more units of a good, the additional satisfaction (utility) gained from each successive unit decreases.
Example:
The first slice of pizza after a long day brings immense satisfaction, but the tenth slice provides very little diminishing marginal utility and might even make you feel sick.
External benefits
Positive spillover effects experienced by third parties who are not directly involved in the production or consumption of a good or service.
Example:
When your neighbor gets their house painted, you experience external benefits because your property value might increase due to the improved neighborhood aesthetics, even though you didn't pay for the paint job.
External costs
Negative spillover effects experienced by third parties who are not directly involved in the production or consumption of a good or service.
Example:
The noise pollution from a late-night concert venue is an external cost to nearby residents trying to sleep, even though they aren't attending the concert.
Externalities
Costs or benefits that affect a third party who is not directly involved in a transaction, leading to a divergence between private and social costs or benefits.
Example:
Both the pollution from a factory and the beautiful garden of a neighbor are examples of externalities, one negative and one positive.
MPB (Marginal Private Benefit)
The additional benefit received by a consumer from consuming one more unit of a good or service, excluding any external benefits.
Example:
The marginal private benefit of buying an extra cup of coffee is the personal enjoyment and energy boost the individual consumer gets from that specific cup.
MPC (Marginal Private Cost)
The additional cost incurred by a producer from producing one more unit of a good or service, excluding any external costs.
Example:
For a bakery, the marginal private cost of baking one more loaf of bread includes the cost of the extra flour, yeast, and labor directly used.
Marginal social benefit (MSB)
The total additional benefit to society from consuming one more unit of a good or service, encompassing both private and external benefits.
Example:
If a city considers adding one more public library, the marginal social benefit would include the added joy of new readers, the increased literacy rates, and the positive impact on community engagement.
Marginal social cost (MSC)
The total additional cost to society from producing one more unit of a good or service, including both private costs and external costs.
Example:
When a power plant decides to generate one more unit of electricity, the marginal social cost includes the cost of fuel and labor, plus the environmental damage from increased emissions.
Market failure
A situation in which the free market, operating on its own, fails to allocate resources efficiently, often due to externalities, public goods, or imperfect information.
Example:
The overfishing of common resources in the ocean is a classic example of market failure because individual incentives lead to depletion of a shared good.
Negative externality
A type of externality where the production or consumption of a good or service imposes costs on third parties not directly involved in the transaction.
Example:
The secondhand smoke from a cigarette smoker is a negative externality for nearby non-smokers who are involuntarily exposed to its harmful effects.
Opportunity cost
The value of the next best alternative that must be foregone when a choice is made.
Example:
If a city decides to build a new sports stadium, the opportunity cost might be the new school or hospital that could have been built with the same resources.
Overproduction
A market outcome where the quantity produced is greater than the socially optimal quantity, typically occurring with negative externalities.
Example:
Industries that generate significant pollution often lead to overproduction of their goods because they don't bear the full social cost of their environmental impact.
Positive externality
A type of externality where the production or consumption of a good or service generates benefits for third parties not directly involved in the transaction.
Example:
Getting a flu shot creates a positive externality because it not only protects the vaccinated individual but also reduces the spread of the virus to others in the community.
Social benefits
The total benefits to society from the production or consumption of a good or service, including both private benefits and external benefits.
Example:
When a community invests in a beautiful public park, the social benefits include not only the enjoyment of park-goers but also increased property values for nearby homes and improved air quality for everyone.
Social costs
The total costs to society from the production or consumption of a good or service, including both private costs and external costs.
Example:
The social costs of a factory polluting a river include the factory's production expenses plus the cleanup costs, health issues for residents, and loss of recreational use of the river.
Socially efficient / Socially optimal outcome
A market outcome where resources are allocated in a way that maximizes total societal welfare, occurring when marginal social benefit equals marginal social cost.
Example:
For a vaccine, the socially optimal outcome is achieved when enough doses are produced that the last vaccine's benefit to society (preventing disease spread) exactly equals its cost of production.
Socially efficient point
The specific quantity and price level in a market where marginal social benefit equals marginal social cost, leading to the optimal allocation of resources for society.
Example:
For public education, the socially efficient point is where the last dollar spent on schooling yields a benefit to society (like a more informed citizenry) exactly equal to that dollar's cost.
Underproduction
A market outcome where the quantity produced is less than the socially optimal quantity, typically occurring with positive externalities.
Example:
Without government intervention, the market for basic scientific research often leads to underproduction because the vast societal benefits are not fully captured by private firms.