Chapter 7-9

Question 1

Welfare economics

Answer 1

the study of how the allocation of resources affects economic well-being

Question 2

Willingness to pay

Answer 2

the maximum amount
that a buyer will pay for
a good

Question 3

consumer surplus

Answer 3

the amount a buyer is
willing to pay for a good
minus the amount the
buyer pays for it

Question 4

cost

Answer 4

the value of everything
a seller must give up to
produce a good

Question 5

producer surplus

Answer 5

the amount a seller is
paid for a good minus the
seller’s cost of providing it

Question 6

efficiency

Answer 6

the property of a resource
allocation of maximizing
the total surplus received
by all members of society

Question 7

equality

Answer 7

the property of distributing
economic prosperity
uniformly among the
members of society

Question 8

Explain how buyers’ willingness to pay, consumer
surplus and the demand curve are related.

Answer 8

if buyers are lower on the demand curve they are less willing to pay. So when they’re lower than the equilibrium they can’t afford the good. Anything above the equilibrium creates a consumer surplus, calculated by price x quantity divided by 2.

Question 9

Explain how sellers’ costs, producer surplus,
and the supply curve are related.

Answer 9

If suppliers are higher on the supply curve they’re more willing to supply. Sellers above equilibrium’s cost is too high so they can’t sell. Sellers below the supply curve represent the producer surplus or profit. Producers lower on the supply curve are more efficient. (Price x quantity) / 2

Question 10

In a supply-and-demand diagram, show the producer
and consumer surplus in the market equilibrium.

Question 11

What is efficiency? Is it the only goal of
economic policymakers?

Answer 11

Efficiency is maximizing the total surplus, and the most efficient is using the invisible hand in a free market. The only goal of economic policymakers is equity as well as how the tax dollars are being used.

Question 12

What does the invisible hand do?

Answer 12

The invisible hand helps buyers and sellers move toward the equilibrium. People acting in their own self-interest.

Question 13

Name two types of market failure. Explain
why each may cause market outcomes to be
inefficient.

Answer 13

1. Externatlities: something that harms a bystander, like pollution or smoking.
2. Market power: monopoly and oligopolies where one person confronts the supply and prices, becoming less efficient.

Question 14

deadweight loss

Answer 14

the fall in total surplus
that results from a market
distortion, such as a tax

Question 15

world price

Answer 15

the price of a good that
prevails in the world
the market for that good

Question 16

tariff

Answer 16

a tax on imports

Question 17

What does the domestic price that prevails
without international trade tell us about a
nation’s comparative advantage?

Answer 17

If the domestic price is low, the cost of producing textiles in Isoland is low, suggesting that Isoland has
a comparative advantage in producing textiles relative to the rest of the world. If the domestic price is high, then the cost of producing textiles in Israel is high,
suggesting that foreign countries have a comparative advantage in producing textiles.
By comparing the world price and the domestic price before trade, we can determine whether Isoland is better or worse at producing textiles than the rest of the world.

Question 18

When does a country become an exporter of a
good? An importer?

Answer 18

A country is an exporter when they have a higher domestic quantity supplied than the domestic quantity demanded, so then they sell to other countries. When the domestic quantity demanded is more than the domestic quantity supplied the country becomes the importer.

Question 19

Describe what a tariff is and its economic effects.

Answer 19

A tariff is a tax imported on goods. A tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade. Tarif causes a deadweight loss because it is a type of tax.

Question 20

List five arguments often given to support trade
restrictions. How do economists respond to
these arguments?

Answer 20

The Jobs Argument Opponents of free trade argue that trade destroys domestic jobs. However, while free trade does destroy inefficient jobs in the importing sector, it creates more efficient jobs in the export sector, industries where the country has a comparative advantage. This is always true because each country has a comparative advantage in the production of something.
The National-Security Argument Some industries argue that their product is vital for national security, so it should be protected from international competition. The danger of this argument is that it runs the risk of being overused, particularly when the argument is made by representatives of industry rather than the defense establishment.
The Infant-Industry Argument New industries argue that they need temporary protection from international competition until they become mature enough to compete. However, there is a problem in choosing which new industries to protect, and once protected, temporary protection often becomes permanent. In addition, industries government truly expects to be competitive in the future don’t need protection because the owners will accept short-term losses.
The Unfair-Competition Argument Opponents of free trade argue that other countries provide their industries with unfair advantages such as subsidies, tax breaks, and lower environmental restrictions. However, the gains of consumers in the importing country will exceed the losses of the producers in that country, and the country will gain when importing subsidized production.
The Protection-as-a-Bargaining-Chip Argument Opponents of frec trade argue that the threat of trade restrictions may result in other countrics lowering their trade restrictions. However, if this does not work, the threatening country must back down or reduce trade neither of which is desirable.

Question 21

What is the difference between the unilateral
and multilateral approaches to achieving free
trade? Give an example of each.

Answer 21

Unilateral approach: remove its trade restrictions on its own. great Britain did this in the 19th century and Chile and South - Korea have done this in recent years. Multilateral approach: reduce its trade restrictions while other countries do the same. So basically bargain with trading partners to reduce trade restrictions around the world.

Question 22

Tax wedge

Answer 22

Difference between what the buyer pays and what sellers receive when tax is placed in a market

Question 23

Laffer curve

Answer 23

Graph showing the relationship between the size of tax and the tax revenue collected.

Question 24

What happens to consumer and producer
surplus when the sale of a good is taxed? How
does the change in consumer and producer
surplus compare to the tax revenue? Explain.

Answer 24

When the sale of a good is taxed, the consumer and producer surplus decreases. A change in consumer and producer surplus exceeds the revenue raised by the government.

Question 25

How do the elasticities of supply and demand
affect the deadweight loss of a tax? Why do
they have this effect?

Answer 25

The more elastic the supply curve, the larger the deadweight loss of the tax. Inelastic line = less deadweight loss of tax. This is because a tax induces people to change their behavior, and if the line is more elastic then the price will affect the quantity greatly, since the elasticity of supply and demand demonstrates how much buyers and sellers respond to changes, it also determines how much a tax distorts the market outcome.

Question 26

Why do experts disagree about whether labor
Do taxes have small or large deadweight losses?

Answer 26

They disagree because economists hold different views about the elasticity of supply and demand. Some think people would work full-time no matter the wage, and others think people would work more based on incentives.

Question 27

What happens to the deadweight loss and tax
revenue when a tax is increased?

Answer 27

When a tax is increased, tax revenue becomes less, but the deadweight loss increases a lot. This is because the market shrinks so much that the revenue starts to fall.

Question 28

Price takers

Answer 28

Market participants who cannot influence the price, so they view the price as given.

Question 29

What is the relationship between the buyer’s willingness to pay for a good and the demand curve for that good?

Answer 29

The height of the demand curve at any quantity is the marginal buyer’s willingness to pay. Therefore, a plot of buyers’ willingness to pay for each quantity is a plot of the demand curve.

Question 30

What is consumer surplus, and how is it measured?

Answer 30

2. Consumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays. It is measured as the area below the demand curve and above the price.

Question 31

What is the value of consumer surplus for the marginal buyer? Why?

Answer 31

3. Zero, because the marginal buyer is the buyer who would leave the market if the price were any higher. Therefore, they are paying their willingness to pay and are receiving no surplus.

Question 32

What is the relationship between the seller’s cost to produce a good and the supply curve for that good?

Answer 32

5. The height of the supply curve at any quantity is the marginal seller’s cost. Therefore, a plot of the sellers’ cost for each quantity is a plot of the supply curve.

Question 33

What is producer surplus, and how is it measured?”

Answer 33

6. Producer surplus is the amount a seller is paid for a good minus the seller’s cost of providing it. It is measured as the area below the price and above the supply curve.

Question 34

When the price of a good rises, what happens to producer surplus? Why?

Answer 34

7. Producer surplus increases because existing sellers receive a greater surplus on the units they were already going to sell and new sellers enter the market because the price is now above their cost.

Question 35

Can a benevolent social planner choose a quantity that provides greater economic welfare than the equilibrium quantity generated in a competitive market? Why?

Answer 35

8. Generally, no. At any quantity below the equilibrium quantity, the market fails to produce units where the value to the marginal buyer exceeds the cost. At any quantity above the equilibrium quantity, the market produces units where the cost to the marginal producer exceeds the value to the buyers.

Question 36

What does an economist mean by “efficiency”?

Answer 36

It is a resource allocation that maximizes the total surplus received by all members of society.

Question 37

Is a competitive market efficient? Why or why not?

Answer 37

10. Yes, because it maximizes the area below the demand curve and above the supply curve, or total surplus.

Question 37

How does a competitive market choose which producers will produce and sell a product?

Answer 37

11. Only those producers who have costs at or below the market price will be able to produce and sell that good.

Question 38

Why does a tax reduce consumer surplus?

Answer 38

Consumer surplus is what the buyer is willing to pay for a good minus what the buyer actually pays and a tax raises the price the buyer actually pays.

Question 39

Why does a tax reduce producer surplus? I

Answer 39

2. Producer surplus is the amount the seller receives for a good minus the seller’s cost and a tax reduces what the seller receives for a good.

Question 40

Why does a tax generally produce a deadweight loss?

Answer 40

3. A tax raises the price buyers pay and lowers the price sellers receive. This price distortion reduces the quantity demanded and supplied so we fail to produce and consume units where the benefits to the buyers exceed the costs to the sellers.

Question 41

Under what conditions would a tax fail to produce a deadweight loss?

Answer 41

4. If either supply or demand were perfectly inelastic (insensitive to a change in price), then a tax would fail to reduce the quantity exchanged and. the market would not shrink.

Question 42

When a tax is placed on a good, does the government collect revenue equal to the loss in total surplus due to the tax? Why or why not?

Answer 42

No. The tax distorts prices to buyers and sellers and causes them to reduce the quantities demanded and supplied. Taxes are collected only on the units sold after the tax is imposed. Those units that are no longer produced and sold generate no tax revenue but those units would have added to total surplus because they were valued by buyers in excess of their cost to sellers. The reduction in total surplus is the deadweight loss.

Question 43

Suppose Rachel values having her house painted at $1,000. The cost for Paul to paint her house is $700. What is the value of the total surplus or the gains from trade on this transaction? What is the size of the tax that would eliminate this trade? What is the deadweight loss from this tax? What generalization can you make from this exercise?

Answer 43

6. Total surplus - 300. Any tax larger than $300. A deadweight loss would be $300. A tax that is greater than the potential gains from trade will eliminate trade and create a deadweight loss equal to the lost gains from trade.

Question 44

Would you expect a tax on gasoline to have a greater deadweight loss in the short run or the long run? Why?

Answer 44

7. There would be a greater deadweight loss in the long run. This is because both demand and supply tend to be more elastic in the long run as consumers and producers are able to substitute away from this market when prices move in an adverse direction. The more a market shrinks from a tax, the greater the deadweight loss.

Question 45

Suppose the supply of oil is relatively inelastic. Would a tax on oil generate a large deadweight loss? Why or why not? Who would bear the burden of the tax, the buyer or the seller of oil? Why?

Answer 45

No. Because the supply of oil is highly inelastic, the quantity supplied is not responsive to a decrease in the price received by the seller. The seller would bear the burden of the tax for the same reason-supply of oil is highly inelastic.

Question 46

As a tax on a good increases, what happens to the deadweight loss from the tax? Why?

Answer 46

Deadweight loss increases continuously because as a tax increases, the distortion in prices caused by the tax causes the market to shrink continuously, Thus, we fail to produce more and more units where the benefits to buyers exceed the costs to sellers.

Question 47

As a tax on a good increases, what happens to tax revenue? Why?

Answer 47

First tax revenue increases. At some point, tax revenue decreases as the distortion in prices to buyers and sellers causes the market to shrink and large taxes are collected on a small number of units exchanged.

Question 48

If the world price for a good is above a country’s before-trade domestic price, will this country import or export this good? Why?

Answer 48

2. Export, because the domestic opportunity cost of production is lower than the opportunity cost of production in other countries.

Question 49

If residents of a country are allowed to import a good, who gains and who loses when compared to the before-trade equilibrium, the producers or the consumers? Why?

Answer 49

3. Consumers gain and producers lose because, if trade is allowed, the domestic price falls to the world price.

Question 50

Describe in words the source of the gains from trade (the additional total surplus) received by an exporting country.

Answer 50

4. The gains are the additional value placed on the exported units by buyers in the rest of the world in excess of the domestic cost of production.

Question 51

Describe in words the source of the gains from trade (the additional total surplus) received by an importing country.

Answer 51

5 The gains are the additional value placed by domestic buyers on the imported units in excess of their cost of production in the rest of the world.

Question 52

Describe in words the source of the deadweight los from restricting trade.

Answer 52

6. The rise in price from restricting trade causes overproduction of the good (production of units that cost more than the world price) and underconsumption of the good (failure to consume units valued more than the world price). ompetitive, and facilitates the spread of technology.

Question 53

For every tariff there is an import quota that will generate a similar result. What are the shortcomings of using an import quota to restrict trade versus using a tariff?

Answer 53

7. The revenue from an import quota will accrue to the license holders or foreign firms and governments unless the domestic government sells the import licenses for the maximum possible amount.

Question 54

What arguments are made to support trade restrictions?

Answer 54

Free trade will destroy domestic jobs, reduce national security, harm infant industries, force domestic producers to compete with foreign companies that have unfair advantages, and allow other countries to have trade restrictions while our country does not.

Question 55

Present the free-trade response to the argument that imports should be restricted on goods that a country needs for national security.

Answer 55

The danger is that nearly any good (far beyond standard military items) can be argued by representatives of industry to be necessary for national security.

Question 56

If tariffs reduce total surplus and, therefore, total economic well-being, why do governments employ them?

Answer 56

Tariffs harm domestic consumers while helping domestic producers. Producers are better able to organize than consumers, and thus, they are better able to lobby the government on their behalf.

Question 57

List other benefits of tree trade beyond those suggested by our standard analysis.

Answer 57

Free trade increases the variety of goods for consumers, allows firms to take advantage of economies of scale, makes markets more competitive, and facilitates the spread of technology.

Question 58

Do you think the tariff/trade war, with acts such as the Smoot–Hawley Tariff, contributed to the severity of the Great Depression in the 1930s, based on what you now know? Explain/give reasons/numbers/dollar figures to justify your answer (from the GATT/WTO assignment we discussed in class).

Answer 58

Yes because the 25% of GDP in the Canadian economy came from exports so without that their economy would fall, however, to make up for that the Commonwealth Bloc helped them financially and through the protection of the products shipped to Canada. Even so, the total volume of world trade fell from a total value of about 3 billion to 1 billion after the implementation of the Smoot-Hawley Tariff Act. In addition to the loss of crops from the farmers during the great depression, they also lost much of their exports during this time, making it nearly impossible to survive.

Question 59

What is some evidence you have come across for the Laffer curve effect? (Recall the videos you watched, and cite evidence that you saw and wrote about on the worksheet/video. A good answer will include numbers/percentages/ and dollar or ruble tax revenue amounts.) See the Laffer Curve assignment that you drop-boxed.’

Answer 59

The Laffer Curve is typically depicted as a bell-shaped curve, with tax revenue on the vertical axis and tax rates on the horizontal axis. The curve implies that there is a point where further increases in tax rates lead to a decline in government revenue, as the negative impact on economic activities outweighs the higher tax rates. For example when tax went from 50% to 12.5% the tax revenue in Ireland was more than 3x bigger. Also in Russia, the top tax rate used to be 30% but then they implemented a 13% flat tax which skyrocketed tax revenue from 175billion rubles in 2000 to more than 930 rubles in 2006, tax revenues have been growing by 19% annually in Russia since then.

Question 60

List and explain two (2) arguments against free trade (i.e. pro-tariffs and import quotas) commonly put forward by domestic lobby groups (special interest groups), and explain one reason why most economists are opposed to tariffs and quotas (i.e. pro-free trade).

Answer 60

The Infant-Industry Argument New industries argue that they need temporary protection from international competition until they become mature enough to compete. However, there is a problem in choosing which new industries to protect, and once protected, temporary protection often becomes permanent. In addition, industries that the government truly expects to be competitive in the future don’t need protection because the owners will accept short-term losses.
The Jobs Argument Opponents of free trade argue that trade destroys domestic jobs. However, while free trade does destroy inefficient jobs in the importing sector, it creates more efficient jobs in the export sector, industries where the country has a comparative advantage. This is always true because each country has a comparative advantage in the production of something.
Economists are pro-free trade because this maximizes total surplus because of the increased competition and productivity, and increases varies of goods because there is goods from all over the world