chapter 7: welfare economics

Question 1

what is positive analysis?

Answer 1

describing what IS happening, explaining why, or predicting what will happen

what is going to happen if we adopt this policy?

Question 2

what is normative analysis?

Answer 2

describe what should happen, which involves value judgements

which is the better outcome, and what policy should the government adopt

Question 3

what is economic efficiency?

Answer 3

an outcome is more economically efficient if it yields more economic surplus

Question 4

what is efficient outcome?

Answer 4

the efficient outcome yields the largest possible economic surplus

hold the potential to make everyone better off

Question 5

what is utility?

Answer 5

level of satisfaction/ happiness

Question 6

what is equity?

Answer 6

a measure of fairness. an outcome yields greater equity if it results in a fairer distribution of economic benefits

Question 7

what is a pareto improvement?

Answer 7

a change which makes at least one party or economic agent better off and makes no parties or economic agents worse off

Question 8

what is a potential pareto improvement?

Answer 8

a change where the parties that benefit from the change could compensate parties made worse off from the change so that at least one party is better off and no parties are worse off

Question 9

what do pareto and potential pareto improvements result in?

Answer 9

increased surplus

Question 10

what is consumer surplus?

Answer 10

the economic surplus you get from buying something

describes the gain from buying something at a price below the highest price you were willing to pay

Question 11

what is the formula for consumer surplus?

Answer 11

consumer surplus = marginal benefit - price

area below demand curve and above price

Question 12

what is the rational rule for buyers?

Answer 12

you should keep buying something until the marginal benefit of that last unit is equal to the price of that unit

Question 13

what is producer surplus?

Answer 13

the economic surplus you get from selling something

describes the gain from selling something at a price above the MC you incur from producing that good or service

Question 14

what is the formula for producer surplus?

Answer 14

producer surplus = price - MC

area under price above supply

Question 15

what is the rational rule for sellers?

Answer 15

keep selling until the MC = P

Question 16

what is voluntary exchange?

Answer 16

buyers and sellers exchange money for goods only if they both want to

does not guarantee that buyers and sellers share equally in the gains from trade

Question 17

what is economic surplus?

Answer 17

economic surplus generated by a transaction is the sum of the consumer surplus enjoyed by the buyer and the producer surplus enjoyed by the seller

also called the total surplus

Question 18

what is the formula for total surplus?

Answer 18

TS = CS + PS

Question 19

what is efficient production?

Answer 19

producing a given quantity of output at the lowest possible cost

requires producing each unit at the lowest MC

Question 20

what is efficient allocation?

Answer 20

allocating goods to create the largest economic surplus

requires that each good goes to the person who will get the highest marginal benefit from it

Question 21

what is efficient quantity?

Answer 21

the quantity that produces the largest possible economic surplus

Question 22

what is the rational rule for markets?

Answer 22

produce more of a good if its marginal benefit is great than (or equal to) the marginal cost

Question 23

what are the five main sources of market failure?

Answer 23

1. market power
2. externalities
3. information problems
4. irrationality
5. government regulations

Question 24

what is an externality?

Answer 24

externalities create side effects

arise whenever the choices that buyers and sellers make side effects on others

Question 25

how does information problem cause market failure?

Answer 25

information problems undermine trust

as a result, people buy or sell less than the efficient quantity

Question 26

what is private information?

Answer 26

information that one party has but the other does not

Question 27

how does irrationality cause market failure?

Answer 27

leads to bad decisions

sometimes people make decisions that are not in their best interests

they rational rule isn’t being followed

Question 28

how does government regulations cause market failure?

Answer 28

governments can impede market forces

taxes, price ceilings, price floors, and quantity regulations

Question 29

what is a deadweight loss?

Answer 29

how far economic surplus falls below the efficient outcome

arises anytime we are not at the efficient quantity

Question 30

what is the formula for DWL?

Answer 30

DWL = economic surplus at efficient outcome - actual economic surplus

Question 31

how can you tell what the DWL is from a graph?

Answer 31

the area between the MC and MB curve between the efficient quantity and actual quantity

Question 32

what is a distributional consequence?

Answer 32

who gets what?

assess whether the outcome seems fair or equitable