Econ 101: Chapter 7 Flashcards
positive analysis
describes what is going to happen; forecasts the effects of the policy
positive analysis involves…
a purely objective analysis
normative analysis
assesses which is the better outcome, and which policy should be adopted.
normative analysis involves…
making a value judgment
efficiency criterion
favours the outcome that generates the most economic surplus.
economic surplus measures…
the benefits that follow from a decision minus the costs that are incurred.
(total benefits - total cost)
economic efficiency
an outcome is more economically efficient if it yields more economic surplus.
efficient outcome
yields the largest possible economic surplus.
efficient outcomes…
won’t make everyone happy.
economic surplus only rises when…
the gains to those helped are larger than the declines in surplus among those that are harmed.
when economic surplus rises, it is possible for…
those who benefit to compensate that who were harmed (ensures that everybody is better off)
This is quite rare in practice.
equity
assesses whether a policy will yield a fair distribution of economic benefits.
consumer surplus
the economic surplus you get from buying something
consumer surplus =
marginal benefit - price
consumer surplus describes…
the gain you get from buying something at a price below the highest price you are willing to pay.
total consumer surplus is…
the area below the demand curve and above the price, out to the quantity sold.
you earn consumer surplus on all but…
your last purchase.
producer surplus
the economic surplus you get from selling something
producer surplus =
price - marginal cost
producer surplus is gained when…
you sell something at a higher price than your marginal costs.
total producer surplus is…
the area above the supply curve and below the price, out to the quantity sold.
you earn producer surplus on all but…
your last sale.
voluntary transactions create…
both producer and consumer surplus (cooperation, so both will only trade if they themselves benefit).
economic surplus =
consumer surplus + producer surplus
OR
marginal benefit - marginal cost
total economic surplus is…
the area between the demand and supply curves, to the left of the quantity bought and sold.
efficient production
occurs when we produce a given level of output at the lowest possible cost.
“Who makes what?”
efficient production means that…
production is allocated so that each item is produced at the lowest marginal cost.
Any production plan other than the one caused by the forces of supply and demand will…
raise costs.
efficient allocation
occurs when goods are allocated to create the largest economic surplus.
“Who gets what?”
efficient allocation requires…
each good to go to the person who gets the highest marginal benefit from it.
any allocation plan other than the once caused by the forces of supply and demand will…
reduce the total amount of economic surplus.
markets allocate goods to those with the…
highest marginal benefit.
efficient quantity
the quantity that produces the largest possible economic surplus.
“How much gets bought and sold?”
the quantity that maximizes economic surplus is the…
equilibrium quantity.
if sellers produce more than the equilibrium quantity…
seller’s marginal cost > buyers marginal benefit.
if sellers produce less than the equilibrium quantity…
buyers marginal benefit > sellers marginal costs
all economic activity is directed by…
the invisible hand (Adam Smith)
market failure
when the forces of supply and demand lead to an inefficient outcome
Market failure causes:
market power, externalities, information problems, irrationality, and government regulations.
market power
the ability of a firm or group of firms to influence the price of a good or service in the market.
undermines competitive pressures.
externalities
the unintended side effects of economic activities that affect others who are not directly involved in the transaction (can be positive or negative)
information problem
Private information - when you’re worried that the folks you’re doing business with know something you don’t.
irrationality
bad decisions - sometimes people make decisions that aren’t in their best interests.
government regulations
impede market forces.
Taxes on buying/selling can lead to a lower quantity bought/sold.
sometimes they push the market away from the efficient quantity.
deadweight loss
how far economic surplus falls below the efficient outcome.
deadweight loss =
economic surplus at efficient quantity – actual economic surplus
when calculating deadweight loss…
focus directly on the marginal benefits/costs.
market failure makes the demand/supply curves…
a poor measure of marginal benefits/costs
what creates deadweight loss?
producing more, or less than the equilibrium quantity.
deadweight loss looks like…
an arrow that points towards the efficient quantity.
government failure
when government policies lead to worse outcomes.
critiques of economic efficiency (1):
Distribution matters, and so it’s also important to account for equity.
critiques of economic efficiency (2):
Willingness to pay reflects ability to pay, not just marginal benefit.
critiques of economic efficiency (3):
The means matter, not just the ends.
- economic efficiency is all about outcome, but the process matters too.
distributional consequences
who gets what; is that fair/equitable.
