4.5 End-of-Chapter Material - savingstudentsmoney.org

Road Map
We start our analysis with a familiar idea: the gains from trade. Figure 13.2 "The Gains from Trade", which also appears in other chapters in this
book, illustrates one of the biggest insights of economics: voluntary transactions create value. In every voluntary transaction, both buyer and
seller obtain surplus from trading. Even more striking, if these transactions take place in a competitive market, then buyers and sellers reap all the
gains from trade.
Figure 13.2
The Gains from Trade
In a competitive market, total surplus (the sum of the buyer surplus and the seller surplus) is maximized.
The first section of the chapter looks at the use of clean air. To start off, we tackle this in a small-scale situation: we consider what happens if a
smoker and a nonsmoker share an office. We ask under what circumstances they might be able to resolve their disagreement without outside
assistance. We then explain that air pollution in Mexico City is really the same problem, albeit much larger. We show that the problem of pollution
has two related aspects: (1) we cannot easily force polluters to pay for their “use” of clean air, and (2) as a result, there is a divergence between the
cost of an action to an individual polluter and the cost to society as a whole.
We discuss different kinds of policies that are used to address these problems. Then we turn to our use of natural resources such as oil. We
consider various kinds of resources and consider what economic theory can teach us about how these resources are likely to be used. Finally, we
consider the implications for economic policy.
13.1 The Economics of Clean Air
LEARNING OBJECTIVES
1. What is the Coase theorem?
2. Why is the Coase theorem important?
3. What is a social dilemma?
If we lived in a world where all economic transactions took place in competitive markets and in which there were “enough” markets, then we would
obtain all the possible gains from trade. This logic falls down in reality because markets sometimes fail, for various reasons.
Something prevents the economy from reaching the competitive outcome.
Something prevents trade altogether, so the market is missing.
Some people other than the buyer and seller are affected by the transaction.