ECON 101 - Chp 6

Question 1

define a price ceiling/cap

Answer 1

government regulation that make sit illegal to charge a price higher than a specified level

Question 2

What’s the effect of a price ceiling above or below the equilibrium price?

Answer 2

above the equilibrium price - there is no effect as the price ceiling does not constrain the market force

below the equilibrium price - there’s an effect as the price ceiling prevents the price from regulating the Qd and Qs - force of law + market forces are in conflict

Question 3

define a rent ceiling + it’s effects

Answer 3

Rent ceiling = when a price ceiling is applied to a housing market

creates a housing shortage, increased search activity + a black market

Question 4

Why does a rent ceiling create a housing shortage?

Answer 4

due to the rent price being set below the equilibrium price, Qs<Qd, thus there’s a housing shortage

Question 5

How can a limited quantity of houses being allocated among frustrated demanders?

Answer 5

increased search activity

Question 6

define search activity in econ context

Answer 6

the time spent looking for someone with whom to do business

Question 7

What’s the opportunity cost of housing?

Answer 7

rent (regulated price) + the time + other resources spent searching for the restricted quantity available

Question 8

Define a black market

Answer 8

an illegal market in which equilibrium price exceeds the price ceiling

Question 9

the level of a black market rent is dependent on what?

Answer 9

how tightly the rent ceiling is enforced

with loose enforcement, the black market rent - close to unregulated rent

with strict enforcement, the black market rent = max price that renter is willing to pay

Question 10

Why is a rent ceiling priced below equilibrium price inefficient?

Answer 10

results in underproduction of housing services - MSB >MSC which creates a deadweight loss –> total surplus decreases

this potential loss from increases search activity is borne by consumers

Question 11

What’s the full loss from a rent ceiling?

Answer 11

the sum of the deadweight loss + increased cost of search

Question 12

Are rent ceilings fair?

Answer 12

fair-rules - anything that blocks voluntary exchange is unfair, so rent ceilings = unfair

Fair-results - fair outcome = one that benefits the less well off - fairest outcome is one that allocates scarce housing to the poorest –> allocate the limited housing quantity through lottery, first-come first-serve, discrimination

rent ceilings are unfair

Question 13

define a price floor

Answer 13

government regulation that makes it illegal to charge a price lower than a specified level

Question 14

effects of a price floor above and below the equilibrium price

Answer 14

price floor set below equilibrium price has no effect

price floor set above equilibrium price prevents the price from regulating Qd and Qs as the force of law + market are in conflict

Question 15

define minimum wage

Answer 15

price floor applied to labour market

Question 16

Does minimum wage bring unemployement?

Answer 16

yes, as the price floor is above the equilibrium leading to Qs>Qd, thus there’s a surplus of labour

Question 17

if minimum wage fair?

Answer 17

delivers an unfair result bc only those people who have jobs + keep them benefit from the minimum wage + unemployed are worse off bc they have no minimum wage + those who search for jobs + find them are worse off bc of the increased cost of job search they incur

imposes an unfair rule bc it blocks voluntary exchange as firms may be wiling to hire more labour + people are wiling to work more, but they are not permitted by the minimum wage law

Question 18

What’s the opportunity cost of supplying labour

Answer 18

leisure forgone

Question 19

Why is an unregulated labour market regarded as efficient?

Answer 19

unregulated labour market allocates the economy’s scarce labour resources to the jobs in which they are valued most highly

Question 20

why is minimum wage inefficient

Answer 20

due to the surplus, a deadweight loss arises, potential loss from increased job search is borne by workers

full loss of minimum wage = deadweight loss + increased cost of job search

Question 21

What are the 2 prices when a transaction is taxed?

Answer 21

1. price that includes tax - buyers respond
2. price that exclude tax - sellers respond

Question 22

define tax incidence

Answer 22

division of the burden of a tax between buyers + sellers

Question 23

Who does the burden fall on when the price paid by buyers rises by the full amount of the tax, by a lesser amount, or not at all

Answer 23

price paid by buyers rises by the full amount of tax, the burden of tax falls entirely on the buyers

price paid by buyers rises by a lesser amount than the tax, then burden falls partly on buyers + sellers

price paid by buyers does not change at all, the burden of tax falls entirely on sellers

Question 24

why are taxes inefficient?

Answer 24

leads to underproduction as MSB>MSC

shrinks producer + consumer surplus + creates deadweight loss

Question 25

describe what happens when there is perfectly inelastic demand + tax incidence?

Answer 25

buyers pay for the tax

as equilibrium quantity doesn’t change, there’s no underproduction + no deadweight loss from the tax when demand is perfectly inelastic

Question 26

What happens there’s perfectly elastic demand + tax incidence?

Answer 26

sellers pay for the tax

equilibrium quantity decreases, there is underproduction + deadweight loss,

Question 27

describe the relationship between deadweight loss + elasticity of demand

Answer 27

deadweight loss increases as elasticity of demand increases.

there’s no deadweight loss when demand is perfectly inelastic

deadweight loss is at its largest when demand is perfectly elastic

Question 28

describe the relationship between tax incidence + elasticity

Answer 28

the more inelastic the demand ism the larger is the amount of tax paid by buyers

Question 29

what happens when there’s perfectly inelastic supply + tax incidence?

Answer 29

sellers pay the tax

equilibrium quantity stays constant, there’s no underproduction + no deadweight loss arising from tax

Question 30

what happens when there is perfectly elastic supply + tax incidence?

Answer 30

buyers pay the tax

equilibrium quantity decreases, there’s underproduction + deadweight loss arises

Question 31

describe the relationship between deadweight loss + elasticity of supply

Answer 31

as the elasticity of supply becomes more elastic, the deadweight loss increases - there’s no deadweight loss when supply is perfectly inelastic + deadweight loss is largest when supply is perfectly elastic

Question 32

describe the relationship between elasticity of supply + tax incidence

Answer 32

the more elastic the supply, the larger the amount of tax is paid by buyers

Question 33

what are the 2 conflicting principles of fairness to apply to a tax system?

Answer 33

1. benefits principle
2. ability-to-pay principle

Question 34

what’s the benefits principle?

Answer 34

proposition that people should pay taxes equal to the benefits they receive from he services provided by the government

this arrangement is fair bc it means those who benefit the most pay the most taxes - makes tax payments + consumption of government-provided services similar to private consumption expenditures

Question 35

what’s the ability to pay principle?

Answer 35

proposition that people should pay taxes according to how easily they can bear the burden of tax - a rich person can more easily bear the burden than a poor person can, this principle reinforces the justification of high rates of income tax on high incomes

Question 36

define production quota

Answer 36

an upper limit to the quantity of a good that may be produced in a specified period

Question 37

what are the effects of production quota above or below the equilibrium quantity

Answer 37

above the equilibrium quantity: nothing would change

below the equilibrium quantity:

1. decrease in supply
   a) production quota decreases the supply of the good as the producer is assigned an production limit that is less than the amount that would be produced without the quota - production in excess of the quota is illegal, supply of the good becomes inelastic at the quantity permitted under the quota
2. increase in price
   b) quota decrease the supply of the good, the price increases
3. decrease in marginal cost
   c) marginal cost decreases because suppliers produce less + stop using resources with the highest marginal cost
4. inefficient underproduction
   d) MSB>MSC, a deadweight loss arises
5. incentive to cheat + overproduce
   e) with the quota, producers can get a larger profit by producing 1 more unit - if all producers produce more than their assigned limit, the production quota is ineffective + price falls back to equilibrium price

Question 38

How to make a productive quota effective

Answer 38

producers must set up a monitoring system to ensure that no one cheats + overproducers

it’s costly to set up + operate + difficult to detects + punish producers who violate their quota

producers often lobby governments to establish a quota + provide the monitoring + punishment systems that make it work

Question 39

define a subsidy

Answer 39

payment made the government to a producer

Question 40

what are the effects of a subsidy?

Answer 40

1. increase in supply
   - since a subsidy decreases the cost, this increases the supply
2. a fall in price + increase in quantity produced
   - subsidy lowers price + increases Qs
3. an increase in marginal cost
   - subsidy lowers the price paid by consumers + increases the marginal cost of growing grain, marginal cost increases because farmers grow more grain which means that they must begin to use some resources that are less ideal for growing grain
4. payments by government to farmers
5. inefficient overproduction
   - MSC>MSB, marginal cost > market price,
   - subsidies spill over to the rest of the world –> subsidized farmers will offer some of their output on the world market which lowers the prices in rest of world, farmers in other countries decrease production + receive smaller revenues

Question 41

prohibition vs taxes

Answer 41

tax revenue can be used to make law enforcement more effective + can be used to run more effective education campaign against illegal drug use

prohibition as it sends a signal that might influence preferences, decreasing demand for illegal drugs

Question 42

does the cost of trading in the good increases when a good is illegal?

Answer 42

yes

Question 43

how much does the cost increases and who bears the cost of trading?

Answer 43

the larger the penalties + the better the policing, the higher are the costs

penalties might be imposed on sellers, buyers, or both - rightward shifts on the supply/demand curve

Question 44

who bears the cost of trading?

Answer 44

depends on the penalties for violating the law + degree to which the law is enforced