4. Government intervention on markets for labour and natural resources (environment) Flashcards
explain monopoly pricing and cartels as a reason for gov intervention
-High risk of monopoly pricing so welfare loss
what are the 3 types of monopoly
monopoly= a single firm dominates a market, leading to higher prices and reduced output, causing welfare loss.
1. Legal monopoly – Protected by patents to encourage innovation (ex: pharmaceutical industry)
2. Cartel – A group of firms acting together to control prices and output.
3. Natural monopoly – Occurs when high fixed costs make it most efficient for a single firm to operate (e.g., electricity grids, railways).
4. ownership
what are the core characteristics of a natural monopoly?
*Huge total fixed costs.
*Decreasing average total costs at high production levels: economy of scales
*Very low marginal costs.
*High risk of monopoly pricing, requiring government intervention to prevent welfare loss.
explain the effects of taxations as a TOOL for gov intervention
*If demand is inelastic, consumers bear most of the tax (higher prices).
*If supply is inelastic, producers bear most of the tax (producers cannot easily change the quantity they supply-> tax -> continue supplying -> price increases-> producers bear most of the tax burden, as their revenue decreases.
*More inelastic demand or supply leads to higher tax revenue.
explain negative externalities
When private costs (costs to firms) are lower than social costs, leading to overproduction and welfare loss (e.g., pollution).
what are the government solutions for negative externalities
Government solutions:
*Coase Theorem: if property rights are well-defined and transaction costs are low, private negotiations will lead to an efficient allocation of resources, regardless of who initially owns the rights.
*Taxation – Imposing taxes on polluters.
*Regulations & Quotas – Setting limits on pollution.
*Tradable Pollution Permits (Cap-and-Trade) – Efficiently controlling total pollution.
what is a positive externalities
when a third party benefits from an economic transaction without being directly involved in it
-> benef not reflected in the market price, so it is when private benefits are lower than social benefits, leading to underproduction (e.g., education, healthcare).
what are the solutions of positive externalities
Subsidies to encourage production, such as vouchers to consumers.
what is tax incidence
who bears the burden of a tax (gov does not determine who ultimately bears the burden—market forces do)
what is a social cost
total cost of an economic activity, including both private costs (borne by firms or consumers) and external costs (borne by society)
what is the difference btwn private and external costs and why is it important
*Private Cost: The direct cost incurred by a producer or consumer (e.g., cost of producing a good).
*External Cost (Negative Externality): Costs imposed on others who are not directly involved in the transaction (e.g., pollution from a factory affecting public health).
*if firms ignore external costs, they overproduce goods that generate negative externalities, leading to market failure.
*Governments intervene (via taxes, regulations, or pollution permits) to make firms internalize the social cost.
what is a labor market
*where workers supply labor and firms demand labor. It determines wages and employment levels.
*Characteristics of a Competitive Labor Market:
-Wages are determined by supply & demand (equilibrium wage).
-Workers are paid based on productivity (VMP).
-No single employer/worker controls wages (perfect competition).
-Job mobility exists – workers can switch jobs freely.
what is VMP
(Value of Marginal Product) measures the additional revenue generated by hiring one more unit of labor.
𝑉𝑀𝑃=MarginalProductofLabor(MP)×PriceofOutput
Marginal Product (MP): The additional output produced by one more worker.
Price of Output: The selling price of the goods produced.
Example: A bakery hires a new worker who can bake 10 additional cakes per day.
If each cake sells for $5, then:
𝑉𝑀𝑃=10×5=50
what is labour demand
driven by the Value of Marginal Product (VMP)
Firms hire workers as long as VMP > wage.
what are the 2 effects of the labour supply
follows a backward-bending curve:
*Substitution effect: Higher wages make work more attractive.
*Income effect: Higher wages also increase the desire for leisure, reducing work hours.
like which market does the labour market works?
*functions similarly to a commodity market (assuming perfect competition):
-Labour Supply: Workers offer their labour in exchange for wages.
-Labour Demand: Firms demand labour based on how much revenue each worker generates (Value of Marginal Product, VMP).
-Equilibrium wage is set where labour supply meets labour demand (just like equilibrium price in a commodity market)
-No Single Buyer or Seller Dominates
-Wages adjust freely based on market conditions (assuming no minimum wages, unions, or government intervention).
-Workers are Paid Based on Productivity (VMP)
what is a commodity market
marketplace where raw materials or primary goods are bought and sold.
Types of Commodities:
Hard commodities: Natural resources like oil, gas, gold, and metals.
Soft commodities: Agricultural products like wheat, coffee, cotton, and livestock.
in a labour market, on what depend the wages
Wages depend on both labour demand (VMP) and labour supply (availability of workers).
–High-skilled labor:
*Higher Demand → High-skilled workers are more productive and generate more revenue for firms (higher VMP).
*Lower Supply → Fewer people have advanced skills.
*Higher Opportunity Cost → High-skilled workers have invested time and money in education/training, so they expect higher wages.
–Low-skilled labour: lower demand, higher supply and lower cost opportunity
what are the direct effects of minimum wages + who wins and loses?
*Effects of minimum wages:
-Reduces labour demand (When wages above the market equilibrium wage, firms find it more expensive to hire workers-> reduce hiring, or replace workers with machines to save costs).
-increases labour supply (higher wages attract more people to look for jobs but since firms are hiring fewer workers, some people cannot find jobs)
→ unemployment.
-Creates welfare loss (In a competitive labour market, wages and employment are at equilibrium-> a minimum wage distorts this balance: economic loss from inefficient job allocation: welfare loss ).
*Who wins and loses?
-Winners: Workers who keep their jobs at a higher wage.
-Losers: Firms and unemployed workers.
what is an income tax? and what is the difference btwn gross and net wages?
tax that governments collect on people’s earnings.
Gross Wage = The total salary a worker earns before taxes and deductions.
Net Wage= The amount a worker actually receives after income tax, social security, and other deductions.
what are the Effects of Income Taxes on the Labour Market
When income taxes increase, they affect the supply and demand for labour, creating distortions in the market:
-Workers receive less net wage, SO some workers may choose to work less or drop out of the labour market because work becomes less financially rewarding-> supply curve shift leftward
-Higher income taxes increase labour costs for firms, which can reduce hiring-> some workers may move to informal jobs
-people work less because of high taxes, so GDP falls; Tax revenue might also decline; economy becomes less efficient because resources (labour) are underutilized.
how is the market for non renewable resources
EX: oil, gas, coal
*Elastic supply in the long run → In the short run, supply is somewhat fixed (existing oil fields cannot be expanded overnight). However, in the long run, new fields can be discovered, making supply more elastic.
*Prices consider future demand (speculation/ “the hotelling principle”)→ Since these resources will eventually run out, prices also include expectations of future scarcity.
*Cartels (e.g., OPEC) can restrict supply to maintain high prices →by limiting production, they can increase prices artificially (even if more oil could be extracted).
how is the market for renewable resources
EX: land
*Supply is inelastic → The total amount of land is fixed; no matter the price, new land cannot be created.
*All income from land is economic rent → Since supply is fixed, landowners do not have production costs, meaning the price paid for land is pure profit (economic rent).
*Price changes benefit landowners → When land prices increase (due to population growth or urbanization), landowners profit without increasing supply.
what is common good/ resources and its challenge
Non-excludable BUT Rivalrous
-> Since no one owns common resources, they are often overused and depleted =Tragedy of the Commons.
-ex: overfishing: Overfishing
Fishermen act in their own interest rather than thinking about long-term sustainability.
Marginal Social Costs (MSC) > Private Costs →Each fisherman only considers their own catch (private cost); not consider the overall depletion of fish stocks (social cost).
Result: Too many fish are caught in the short run, leading to fish population collapse in the long run
