ECON 101 - Chp 6 Flashcards
define a price ceiling/cap
government regulation that make sit illegal to charge a price higher than a specified level
What’s the effect of a price ceiling above or below the equilibrium price?
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
define a rent ceiling + it’s effects
Rent ceiling = when a price ceiling is applied to a housing market
creates a housing shortage, increased search activity + a black market
Why does a rent ceiling create a housing shortage?
due to the rent price being set below the equilibrium price, Qs<Qd, thus there’s a housing shortage
How can a limited quantity of houses being allocated among frustrated demanders?
increased search activity
define search activity in econ context
the time spent looking for someone with whom to do business
What’s the opportunity cost of housing?
rent (regulated price) + the time + other resources spent searching for the restricted quantity available
Define a black market
an illegal market in which equilibrium price exceeds the price ceiling
the level of a black market rent is dependent on what?
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
Why is a rent ceiling priced below equilibrium price inefficient?
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
What’s the full loss from a rent ceiling?
the sum of the deadweight loss + increased cost of search
Are rent ceilings fair?
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
define a price floor
government regulation that makes it illegal to charge a price lower than a specified level
effects of a price floor above and below the equilibrium price
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
define minimum wage
price floor applied to labour market
Does minimum wage bring unemployement?
yes, as the price floor is above the equilibrium leading to Qs>Qd, thus there’s a surplus of labour
if minimum wage fair?
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
What’s the opportunity cost of supplying labour
leisure forgone
Why is an unregulated labour market regarded as efficient?
unregulated labour market allocates the economy’s scarce labour resources to the jobs in which they are valued most highly
why is minimum wage inefficient
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
What are the 2 prices when a transaction is taxed?
- price that includes tax - buyers respond
- price that exclude tax - sellers respond
define tax incidence
division of the burden of a tax between buyers + sellers
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
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
why are taxes inefficient?
leads to underproduction as MSB>MSC
shrinks producer + consumer surplus + creates deadweight loss
describe what happens when there is perfectly inelastic demand + tax incidence?
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
What happens there’s perfectly elastic demand + tax incidence?
sellers pay for the tax
equilibrium quantity decreases, there is underproduction + deadweight loss,
describe the relationship between deadweight loss + elasticity of demand
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
describe the relationship between tax incidence + elasticity
the more inelastic the demand ism the larger is the amount of tax paid by buyers
what happens when there’s perfectly inelastic supply + tax incidence?
sellers pay the tax
equilibrium quantity stays constant, there’s no underproduction + no deadweight loss arising from tax
what happens when there is perfectly elastic supply + tax incidence?
buyers pay the tax
equilibrium quantity decreases, there’s underproduction + deadweight loss arises
describe the relationship between deadweight loss + elasticity of supply
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
describe the relationship between elasticity of supply + tax incidence
the more elastic the supply, the larger the amount of tax is paid by buyers
what are the 2 conflicting principles of fairness to apply to a tax system?
- benefits principle
- ability-to-pay principle
what’s the benefits principle?
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
what’s the ability to pay principle?
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
define production quota
an upper limit to the quantity of a good that may be produced in a specified period
what are the effects of production quota above or below the equilibrium quantity
above the equilibrium quantity: nothing would change
below the equilibrium quantity:
- 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 - increase in price
b) quota decrease the supply of the good, the price increases - decrease in marginal cost
c) marginal cost decreases because suppliers produce less + stop using resources with the highest marginal cost - inefficient underproduction
d) MSB>MSC, a deadweight loss arises - 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
How to make a productive quota effective
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
define a subsidy
payment made the government to a producer
what are the effects of a subsidy?
- increase in supply
- since a subsidy decreases the cost, this increases the supply - a fall in price + increase in quantity produced
- subsidy lowers price + increases Qs - 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 - payments by government to farmers
- 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
prohibition vs taxes
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
does the cost of trading in the good increases when a good is illegal?
yes
how much does the cost increases and who bears the cost of trading?
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
who bears the cost of trading?
depends on the penalties for violating the law + degree to which the law is enforced
