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When does equilibrium also reflect maximizing social benefits? - Mike - 10-12-2012 11:23 PM
Can anyone help me out? I'm having trouble with my economics homework.
Within a market, since demand is assumed to reflect private benefits and supply reflects private costs, equilibrium reflects maximizing net private benefits. When does this equilibrium also reflect maximizing social benefits? When does it not reflect maximizing social benefits? In the cases where it does not, elucidate the problem.
- mikethechampion - 10-12-2012 11:31 PM
The demand and supply curves represent the private benefits and costs in the market.
There is also a Social demand and supply curve that represent the private benefits and costs of each level of quantity to society as a whole.
For example, in the market for vaccines, you private demand curve for a vaccine will not coincide with the social demand curve, because you won't take into account that if you have a vaccine, you'll be helping society by not spreading disease. There is an additional benefit to society of you having a vaccine that you won't internalize, so your demand curve is lower than the social demand curve (or the social marginal benefit curve) and society as a whole will consume fewer vaccines then is optimal.
This additional benefit is called an "externality".
So an equilibrium reflects a social optimum when the private demand and supply curves are the same as the social demand and supply curves; when there are no externalities in the market.
Another example is pollution. When a firm pollutes, it is costing society, but the firm might not care so its private costs are lower than the social costs, so the firm supply curve will be higher than the social supply curve.
A pigouvian tax is a tax levied by the government so that the private costs and benefits equal the social costs and benefits. A tax on pollution so that the cost of polluting equals the social cost would be called a pigouvian tax.