Important aspects of microeconomics are reviewed in this chapter. An economy is Pareto efficient if it is not possible to make at least one person better off without making someone else worse off. Market efficiency requires that marginal social benefits equal marginal social costs. Public goods are nonrival, meaning that one additional person can consume the good without reducing any other consumer’s benefit. After a nonrival good is produced, the marginal social cost of another consumer is zero, so efficiency requires a zero price. An externality exists if one economic agent’s action (consumption or production) affects another agent’s welfare outside the market. When externalities are present, private choices by consumers and firms in private markets generally will not provide an economically efficient result. Government may be able to intervene and create incentives through the use of taxes, subsidies, or regulations so that private choices of consumers and firms will be efficient in the presence of externalities. If production of some commodities exhibits increasing returns to scale, it is impossible to have a single price equal to marginal cost (which is required for efficiency) and have the producer earn a profit. Government may resolve this difficulty either by becoming the producer or by regulating monopoly production. Many, although not all, state-local government activities can be explained by the problems of public goods, externalities, and increasing returns to scale. Redistribution of society’s resources also can be a legitimate and explicit objective of government policy.
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