Econ 101 Test 2 Flashcards
price ceiling
a legal maximum on the price of a good or service
price floor
a legal minimum on the price of a good or service
taxes
the government can make buyers or sellers pay a specific amount on each unit
A binding price ceiling creates a (shortage/surplus)
shortage
A binding price floor creates a (shortage/surplus)
surplus
tax incidence
how the burden of a tax is shared among market participants (how much the buyer/seller pays)
a tax drives a wedge between
the price buyers pay and the price sellers receive
if supply is more elastic than demand, the tax burden will fall more heavily on the
buyers because it is easier for the sellers to leave the market
if demand is more elastic than supply, the tax burden will fall more heavily on the
sellers because it is easier for the buyers to leave the market
welfare economics
studies how the allocation of resources affects economic well-being
the allocation of resources refers to
how much of each good is produced, which producers produce it, and which consumers consume it
a buyer’s willingness to pay for a good is
the maximum amount the buyer will pay for that good (how much the buyer values the good)
the marginal buyer is the buyer who
would leave the market if the price were any higher
consumer surplus
the amount a buyer is willing to pay minus the amount the buyer actually pays (CS = WTP - P)
cost
the value of everything a seller must give up to produce a good (i.e. opportunity cost)
the marginal seller is the seller who
would leave the market if the price were any lower
producer surplus
the amount a seller is paid for a good minus the seller’s cost (PS = P - cost)
total surplus
CS + PS; total gains from trade in a market; value to buyers - cost to sellers
an allocation of resources is efficient if it maximizes
total surplus
the market equilibrium quantity (maximizes/minimizes) total surplus; at any other quantity, you can increase total surplus by moving (toward/away from) the market equilibrium quantity
maximizes; toward
invisible hand
Adam Smith; guides the economy
laissez faire
“allow them to do”; the government should not interfere with the market
deadweight loss
the fall in total surplus that results from a market distortion, such as tax
when supply or demand is inelastic, it is (harder/easier) to leave the market when the tax reduces Ps so the DWL is (small/large) since the Q reduces a (little/lot)
harder; small; little
when supply or demand is elastic, it is (harder/easier) to leave the market when the tax reduces Ps so the greater Q falls below the surplus-maximizing quantity, the (greater/lesser) the DWL
easier; greater
doubling the tax causes the DWL to ? and tripling it causes the DWL to ?; so, when a tax increases, DWL ?
more than double/triple; rises even more (right half of a parabola)
the Laffer curve
shows the relationship between the size of the tax and tax revenue (-x^2)
the world price of a good is the
price that prevails in world markets
if Pd < Pw
country has comparative advantage in the good; exports
if Pd > Pw
country does not have comparative advantage; imports
tariff
a tax on imports
arguments for restricting trade
- jobs
- national security
- infant-industry
- unfair-competition
- protection-as-bargaining-chip
the jobs argument
Trade destroys jobs in industries that compete
with imports.
the national security argument
An industry vital to national security should be
protected from foreign competition, to prevent
dependence on imports that could be disrupted
during wartime.
the infant-industry argument
A new industry argues for temporary protection
until it is mature and can compete with foreign
firms.
the unfair-competition argument
Producers argue their competitors in another
country have an unfair advantage,
e.g. due to govt subsidies.
the protection-as-a-bargaining-chip argument
Example: The U.S. can threaten to limit imports of French wine unless France lifts their quotas on American beef.
trade agreements
a country can liberalize trade with unilateral reductions in trade restrictions and multilateral agreements with other nations (ex: NAFTA, GATT, WTO)
a tariff benefits ? and generates revenue for the government, but the losses to consumers (does not exceed/exceeds) these gains
producers; exceeds
if a country exports, trade
raises producer surplus, reduces consumer surplus, and raises total surplus
if a country imports, trade
reduces producer surplus, raises consumer surplus and total surplus
externality
one type of market failure; the uncompensated impact of one person’s actions on the well-being of a bystander; can be negative or positive
examples of negative externalities:
air pollution from a factory, neighbor’s barking dog, health risk to others from second-hand smoke, etc.
private cost
the cost directly incurred by sellers
private value
the value to buyers (WTP)
social cost
private + external cost
external cost
value of the negative impact on bystanders
internalizing the externality
altering incentives so that people take account of the external effects of their actions (ex: introduce a tax)
examples of positive externalities:
vaccination, going to college
in the presence of a positive externality, social value includes
private value (direct value to buyers) and external benefit (the value of the positive impact on bystanders)
two approaches to public policies toward externalities
- command-and-control (regulate behavior directly: ex - limits on quantity of pollution emitted)
- market-based policies (provide incentives so that private decision-makers will choose to solve the problem on their own: ex - corrective taxes/subsidies and tradable pollution permits)
corrective tax
a tax designed to induce private decision-makers to take account of the social costs that arise from a negative externality (AKA Pigouvian taxes)
the ideal corrective tax is the ? or (for activities with positive externalities) ?
external cost, external benefit
are corrective taxes or regulations better?
corrective taxes
with tradable pollution permits, firms with a low cost of reducing pollution ? and firms with high cost of reducing pollution ?
do so and sell their unused permits, buy permits
the Coase theorem
if private parties can costlessly bargain over the allocation of resources, they can solve the externalities problem on their own
why do private solutions not always work?
- transaction costs (the costs parties incur in the process of agreeing to and following thru on a bargain - may make it impossible to reach a mutually beneficial agreement)
- stubbornness (even if a beneficial agreement is possible, each party may hold out for a better deal)
- coordination problems (if the number of parties is very large, coordinating them may be costly, difficult, or impossible)
a good is excludable if
a person can be prevented from using it (ex: fish tacos, wireless Internet access)
a good is NOT excludable if
a person cannot be prevented from using it (ex: AM/FM radio signals, national defense)
a good is rival in consumption if
one person’s use of it diminishes others’ use (ex: fish tacos)
a good is NOT rival in consumption if
one person’s use of it does not diminish others’ use (ex: an MP3 file of Lady Gaga’s latest single)
What are the four different kinds of goods?
- private goods
- public goods
- common resources
- club goods
private goods + ex
excludable, rival in consumption (ex: food)
public goods + ex
not excludable, not rival (ex: national defense)
common resources + ex
rival but not excludable (ex: fish in the ocean)
club goods + ex
excludable but not rival (ex: cable TV)
public goods are difficult for private markets to provide because of the ? problem
free-rider (a person who receives the benefit of a good but avoids paying for it)
if the benefit of a public good exceeds the cost of providing it, gov’t should (not provide/provide) the good and pay for it with a tax on people who benefit
provide
cost-benefit analysis
a study that compares the costs and benefits of providing a public good (imprecise)
the tragedy of the commons
when common resources get used more than is socially desirable
