Chapter 6 (1)

Question 1

Recap

Answer 1

► Markets gravitate toward equilibrium;

►When markets work well, prices adjust until the quantity of the good demanded is equal to the quantity supplied.

►Equilibrium price & quantity = also maximize total surplus –> thus @ E there is no way to make some people better off w/out harming others

Question 2

(3) REASONS WHY A GOV’T MAY STEP IN AND INTERVENE IN A MARKET:

Answer 2

1. Correcting Market Failures
2. Changing the Distribution of Surplus
3. Encouraging / Discouraging Consumption

Question 3

CORRECTING MARKET FAILURES

Answer 3

Our model of demand and supply has so far assumed that markets work efficiently—but in the real world, that’s not always true

Example: sometimes there is only one producer of a good –> who faces no competition and can charge an inefficiently high price

► Other times, one person’s use of a product or service imposes costs on other people that are not captured in prices paid by the first person (e.g., pollution caused by burning the gas in your car)
> aka externality

Question 4

MARKET FAILURES

Answer 4

Situations in which the assumption of efficient, competitive markets fails to hold

► When there is a market failure, intervening can actually increase total surplus.

Question 5

CHANGING THE DISTRIBUTION OF SURPLUS

Answer 5

Efficient markets maximize total surplus –> but an efficient outcome may still be seen as unfair.

Example: even if the job market is efficient, wages can still drop so low that some workers fall below the poverty line while their employers make healthy profits

► Gov’t = might respond by intervening in the labor market to impose a minimum wage

► This policy = will change the distribution of surplus –> reducing employers’ profits and lifting workers’ incomes

Question 6

ENCOURAGING / DISCOURGAING CONSUMPTION

Answer 6

around the world, many people judge certain products to be “good” or “bad” based on culture, health, religion, or other values

► At the extreme, certain “bad” products are banned altogether (e.g., hard drugs)

More often, governments use taxes to discourage people from consuming bad products without banning them altogether

• Example: cigarettes and alcohol –> many governments tax them heavily, with the aim of reducing smoking and drinking
• In some cases, minimizing costs imposed on others (e.g., from pollution or secondhand smoke) = also part of the motivation for discouraging consumption

► On the other hand, governments use subsidies to encourage people to consume “good” products or services.

Example: many governments provide public funding for schools –> to encourage education and for vaccinations to encourage parents to protect their children against disease.