econ 1021 mid 2 Flashcards
Market price
Allocates resources by setting a market price. The “choose not to pay” section generally consists of those who can afford to pay and choose not to, and those who cannot afford to pay. Most essential items are not allocated by market price for this reason.
Command
A command system has someone with authority allocating resources. In Canada this system is used inside firms and government departments (allocation of labour for example). The command system works badly in an economy because it is too large to be controlled.
Majority rule
Allocated how the majority sees fit. Many government services as well as taxes are decided this way.
Lottery
Allocate resources to those who win a draw or type of game that revolves around luck. Many airports, marathons, and wireless service providers use this system to award services.
Contest
Allocates resources to a winner or group of winners.
First-come, first-served
Allocates resources to those who are first in line. Highways use this method to fill up lanes (cars come on the on ramp in an order). Restaurants that don’t accept reservations also use this method to fill their tables.
Personal characteristics
People with the “right” characteristics get the resources.
Force
Using force plays a crucial role in allocating resources. A good example of this is during war. Small-scale and large-scale crime also allocate billions of dollars in scarce goods annually. Also allows for the state to allocate wealth between rich and poor
Price
What we pay.
Value
What we get
Marginal benefit
Value of one more unit of a good or service.
A demand curve
is a marginal benefit curve because we measure marginal benefit by willingness to pay.
Market demand curve
The demand of the ENTIRE market is found by adding the quantities demanded of all individuals at each price.
Also known as the marginal social benefit curve (social meaning the entire market)
Consumer surplus
Excess benefit received from a good over the amount paid for it.
individual demand
The relationship between the price of a good and the quantity demanded by one person
market demand
The relationship between the price of a good and the quantity demanded by all buyers in the market
We can calculate consumer surplus
as the marginal benefit (or value) of a good minus its price, summed over the quantity bought.
It is measured by the area under the demand curve and above the price paid, up to the quantity bought.
Cost
What a firm gives up to produce a good or service.
Price
What a firm receives when they sell a good or service.
Marginal cost
The cost of producing one more unit of a good or service.
Thus, this is the minimum price that producers must receive to induce them to offer one more unit of a good or service
A supply curve
is a marginal cost curve because the minimum supply price determines supply.
Market supply curve
The quantity supplied by the ENTIRE market is found by adding the quantities supplied of all firms at each price.
Also known as the marginal social cost curve (social meaning the entire market)
Producer surplus
The excess of the amount received from the sale of a good or service over the cost of producing it.
individual supply
The relationship between the price of a good and the quantity supplied by one producer
market supply
The relationship between the price of a good and the quantity supplied by all producers in the market
ALLOCATIVE EFFICIENCY
Since the marginal social cost and benefit curves are supply and demand curves, ALLOCATIVE EFFICIENCY is achieved when the two curves reach equilibrium.
Equilibrium
means that a good or service is worth exactly what it costs to consumers.
Total surplus
The SUM of the producer and consumer surplus. This value is maximized at equilibrium.
Market failure
When a market is inefficient.
In this scenario, either too little or too much of a good or service is being produced
Deadweight loss
The decrease in total surplus that results from an inefficient level of production.
When production is …
less than the equilibrium quantity, MSB > MSC.
greater than the equilibrium quantity, MSC > MSB.
equal to the equilibrium quantity, MSC = MSB.
The Invisible Hand
Adam Smith’s “invisible hand” idea in the Wealth of Nations implied that competitive markets send resources to their highest valued use in society.
Consumers and producers pursue their own self-interest and interact in markets.
Market transactions generate an efficient—highest valued—use of resources.
Price and quantity regulations
Price caps and price floors block the market from adjusting prices in order to fix inefficiencies and return to equilibrium. Regulating the amount a firm can produce can also lead to underproduction.
Taxes and subsidies
Taxes increase the amount paid by buyers, lower the amount received by sellers, and thus lead to underproduction. Subsidies decrease the prices paid by buyers, increase the prices received by sellers, and lead to overproduction.
Externalities
External costs are additional costs not considered which lead to overproduction. External benefits are additional benefits not considered when originally planning that lead to underproduction.
Public goods and common resources
These public goods are goods or services that everyone benefits from. A competitive market would underproduce these resources because everyone would try to free ride on everyone else. Common resources are owned by everyone to be used by everyone. As a result of this, they are overused.
Monopoly
This is a firm that is a sole provider of a good or service. Since these companies do not compete and work in their self-interest, they underproduce because they produce too little and charge too much.
High transactions costs
These costs are additional costs incurred with a purchase. Buying a house will include transactions costs for lawyers and realtors, for example. Some markets are too costly to be in that transactions costs are useless, and some markets might underproduce when transactions costs are high.
Alternatives to allocate resources
more efficiently include, majority rule, command systems, and first-come first-served.
On the issue of fairness
all economists agree that the size of the economic pie should be maximized and produced at the lowest possible cost.
Ideas about fairness can be divided into two groups
It’s not fair if the result isn’t fair.
It’s not fair if the rules aren’t fair.
Big tradeoff
Tradeoff between efficiency and fairness. It is based on the following facts: Income can only be transferred from high to low incomes by means of taxation. Taxing people’s income makes them work less, which results in quantity of labour being less than the efficient quantity. Additionally, taxing people’s capital results in a less than efficient quantity of capital. Thus, the quantity of goods and services are less than the efficient quantity.
The economic pie SHRINKS from this
Thus, the greater amount of taxation the less efficient the economy
Another inefficiency is the fact that taking a dollar from a rich person does not give a dollar to a poor person. The amount diminishes in value as government agencies and taxation services take their cut from the tax amount
Also states that poorer people could be worse off too, as more taxes could lead to entrepreneurs shutting down businesses that employ people of lower incomes
AS A RESULT, no economist today believes that the pie should be divided evenly because of the risks described within the big tradeoff
Utilitarianism
is the principle that states that we should strive to achieve “the greatest happiness for the greatest number
It’s not fair if the RESULT isn’t fair (thought one)
General idea is that it’s unfair if people’s incomes are too unequal.
Economists in the nineteenth century thought that for the market to be fair then there needed to be equality of incomes. This idea turned out to be wrong.
These thinkers believed in UTILITARIANISM – the idea that we must bring the greatest amount of happiness to the greatest number of people.
They believed that to achieve this, income must be transferred from the rich to the poor
Reasoned that the marginal benefit is greater for a thousandth dollar for a poor person compared to a millionth dollar for a rich person
A new theory in response to this was proposed by philosopher John Rawls in a 1971 book titled A Theory of Justice.
Rawls said that the fairest distribution of the economic pie is the distribution that makes the poorest as well off as possible
Thus, taxes should be set so that they are not high enough to massively hinder on efficiency, but enough to ensure the pie is large and poor people are benefiting from the wealth generated from it
This ratio will most likely not be an equal share
It’s not fair if the RULES aren’t fair (thought two)
This idea is based off of the SYMMETRY PRINCIPLE – the idea that individuals in similar situations should be treated similarly
“Behave toward other people in a way you expect them to behave toward you”
In economics, this principle translates into equality of opportunity
Philosopher Robert Nozick reinforced this view in economics in his 1974 book Anarchy, State, and Utopia
He says that fairness mustn’t be based on the outcome or result, but rather on the rules. He suggests that fairness obeys two rules:
The state must enforce laws that establish and protect private property – theft must be prevented
Private property can only be transferred from one individual to another by voluntary exchange
If these two rules are followed, it does not matter how unequal the economic pie is.
Economists have theorized that if these principle rules are followed, the economy will function efficiently, as resource allocation will be efficient
According to Nozick, no matter how unequal the resulting wealth distribution is, it will be equal
Scarcity prevents everyone from being well off
Price ceiling/cap
Government regulation that makes it illegal to charge a price higher than a specified level.
Price ceiling above equilibrium has no affect on the market
A price ceiling below the equilibrium will have large effects and create a shortage (QS is less than QD)
rent ceiling
When a price ceiling is applied to a housing market it
If the rent ceiling is set above the equilibrium rent, it has no effect. The market works as if there were no ceiling.
But a rent ceiling set below the equilibrium rent creates
A housing shortage
Increased search activity
An illicit market
A rent ceiling set below equilibrium rents creates
A housing shortage
Increased search activity
Search activity is the time spent looking for someone with whom to do business
Opportunity cost of housing is equal to the rent (a regulated price) plus the time and other resources spent searching for the restricted quantity available
This could make the cost of housing higher than what it would be without the rent ceiling
A black market
With loose enforcement this rent is close to the unregulated rent, but with strict enforcement it is equal to the maximum price that a renter is willing to pay
Rent ceilings set below the equilibrium
result in MSB exceeding MSC and creating a deadweight loss that restricts both consumer and producer surplus.
Potential loss from housing search (all borne by consumers) + deadweight loss + overall loss
Increased Search Activity
When a price is regulated and there is a shortage, search activity increases.
Search activity is costly and the opportunity cost of housing equals its rent (regulated) plus the opportunity cost of the search activity (unregulated).
Because the quantity of housing is less than the quantity in an unregulated market, the opportunity cost of housing exceeds the unregulated rent
search activity
The time spent looking for someone with whom to do business
illicit market
is an illegal market that operates alongside a legal market in which a price ceiling or other restriction has been imposed.
A shortage of housing creates an illicit market in housing.
Illegal arrangements are made between renters and landlords at rents above the rent ceiling—and generally above what the rent would have been in an unregulated market.
A rent ceiling decreases the quantity of housing supplied to less than the efficient quantity.
A deadweight loss arises.
Consumer surplus shrinks.
Producer surplus shrinks.
There is a potential loss from increased search activity
Mechanisms for allocating regulated rents
Lottery
First-come, first-served
Discrimination
Price floor
A government regulation that makes it illegal to charge a price lower than a specified level
Price floor set below equilibrium has no effect on the market
A price floor set above the equilibrium creates a surplus of jobs (QD is less than QS)
A price floor applied to the labour market
is called a minimum wage.
A minimum wage set above equilibrium creates unemployment
If the minimum wage is set below the equilibrium wage rate, it has no effect. The market works as if there were no minimum wage.
If the minimum wage is set above the equilibrium wage rate, it has powerful effects
