The market equilibrium quantity is equal to the socially optimal quantity only when all social benefits and costs are internalized by individuals in the market. Total economic surplus is maximized at that quantity.

Rational agents can pursue private actions to exploit or exercise market characteristics known as market power.

Rational agents make optimal decisions by equating private marginal benefits and private marginal costs that can result in market inefficiencies.

Policymakers use cost-benefit analysis to evaluate different actions to reduce or eliminate market inefficiencies.

Market inefficiencies can be eliminated by designing policies that equate marginal social benefit with marginal social cost.

Equilibrium allocations can deviate from efficient allocations due to situations such as monopoly; oligopoly; monopolistic competition; negative and positive externalities in production or consumption; asymmetric information; and insufficient production of public goods.

Producing any non-efficient quantity results in deadweight loss.

The socially optimal quantity of a good occurs where the marginal social benefit of consuming the last unit equals the marginal social cost of producing that last unit, thus maximizing total economic surplus.

Externalities are either positive or negative and arise from lack of well-defined property rights and/or high transaction costs.

In the presence of externalities, rational agents respond to private costs and benefits and not to external costs and benefits.

Rational agents have the incentive to free ride when a good is non-excludable.

Policies that address positive or negative externalities include taxes/subsidies, environmental regulation, public provision, the assignment of property rights, and the reassignment of property rights through private transactions.

Explain (using graphs where appropriate) why resource allocation in perfectly competitive markets is socially efficient.

Explain (using graphs where appropriate) how private incentives can lead to actions by rational agents that are socially undesirable (inefficient) market outcomes.

Explain equilibrium allocations in imperfect markets relative to efficient allocations (using graphs where appropriate) and why these markets are inefficient.

Calculate (using graphs where appropriate) the deadweight loss resulting from the production of a non-efficient quantity.

Define externalities.

Explain (using graphs where appropriate) how in the presence of externalities, private markets do not take into consideration social costs or social benefits.

Explain (using graphs where appropriate) how public policies address positive or negative externalities.