ECON final Flashcards
What determines the elasticity of demand?
Availability of a close substitute: if consumers can easily get an alternative good, they will be more price sensitive, if consumers can’t, they will be less price sensitive (eg. Gasoline has a very low elasticity since there aren’t many alternatives, while chicken breasts are very high since there are many alternatives like beef or pork.)
Passage of time: it takes time for consumers to adapt to changes In the market, over longer periods of time, demand becomes more elastic
For example: if youre upset with current gas prices there isn’t much you can do, but over the next few years when your car is at the end of its life, you can switch to a tesla.
Luxury vs necessities: consumers are more price sensitive with respect to luxury goods they can live without compared to nessecities
Example: water is very inelastic, but coca cola is elastic
Definition of market: if we define the market as very broad, it will be more inelastic since it has fewer substitutes, if we define it as a specific product from a specific brand it will be more elastic:
For example: the demand for cars is inelastic while the demand for Toyota, or Mercedes specifically, is elastic
Share of a consumer budget: if the money spent on the good is a larger share of the consumer’s budget, demand will be more elastic.
If income elasticity > 0
normal good
- A consumers budget depends on 3 things:
Income from various sources
Ability to borrow
Savings
If income elasticity is >1
Luxury good
If income elasticity is < 0,
inferior good
If 0 ≤ income elasticity ≤1
necessity good.
- If the cross-price elasticity is < 0
they are compliments
- If the Cross-Price Elasticity > 0
A and B are substitutes
- Determinants of price elasticity of supply:
Availability of inputs: If inputs (labour, materials, capital) are easy to obtain, firms can easily increase production in response to price increases. Supply will be more elastic.
Passage of time: over a short time frame, its difficult to manage workers and materials (you cant hire a new department and get materials in a day), but over a large time frame, its easier to manage inputs, making supply more elastic
with regards to marginal utility, consumers will be best off when?
MUx/Px = MUy / Py
- If the cross-price elasticity is = 0
there is no relationship
- A consumer’s willingness to purchase a product depends on:
Desire for the product
How much they value the good relative to other goods
How much income do they have available to spend
network externality
There is a network externality in the consumption of a product if the usefulness of the product increases with the number of consumers who use it.
o If PxX + PyY < M, then the purchase is …?
Affordable or within budget
in perfect competition firms are price:
takers
perfect competition criteria:
- Theres many buyers and sellers, and each one is “small” relative to the overall market size, so they cannot affect the market price with their own actions.
- Each firm produces a homogenous good (this means that products from different firms are perfect substitutes for each other) this means consumers will only consider the price and only buy from the lowest-priced firm.
- There is perfect information about prices and quality of goods
- There are no transaction costs – no added fees or commitments (the price the buyer sees is the price they pay)
- Firms can easily enter and exit the market
whats the optimum?
The point where the budget constraint and the indifference curve are tangent, maximizing utility within budget
Because a monopolistically competitive firm has control over its price, we call it a price
setter
sources of product differentiation
- Actual or perceived difference in materials, quality, etc
- Brand name or reputation
- Location, convenience
- Transaction costs, lock-in, and switching costs
- Incomplete information
types of innovation
Product innovation
* Creates new goods and therefore new markets from which society can draw economic surplus. The creation of new markets therefore leads to an increase in social welfare (see Unit 4).
Process innovation
* New production processes improve productive efficiency: new methods of producing allow for greater output with fewer inputs.
oligopoly barriers to entry
- Economies of Scale
- Government Regulations
- Limited Ownership of a resource
- Operating history and brand recognition
two-part tariffs
firms charge a membership or entrance fee as well as a fee for use fee.
junk fee,
firm charges a processing fee or administrative charge in addition to the stated price
Loss Leader,
this is an item sold below cost and typically advertised as being on sale.
price discrimination only works if
- The firm has Market Power.
- The firm can identify customers who are willing to pay more than others.
- The firm can prevent resale.
3rd degree price discrimination
Multi market
Charge diff prices to diff market segments
Could be segmented by geography, age, student status, etc.
In segmented markets, the price discrimination of splitting a market into segments results in a higher producer surplus then just charging one price for the whole market
2nd degree price discrimination
Quantity-based
Offer bulk discounts
Those wanting to buy a small quantity, pay a higher price, leading to them taking some consumer surplus into producer surplus
1nd degree price discrimination
Perfect
o Charge each customer their exact willingness to pay.
o This makes a firm take all consumer surplus for itself, so there is no consumer surplus.
o Whats interesting about this that MR curve = d curve. Before the MR was steeper because the firm had to lower their price to sell more output, but here the firm doesn’t have to change prices.
o The new profit maximizing point is where MC = demand (since MR = d) leading to the same quantity as a perfectly competitive market and no DWL.
a negative network externality makes a social cost curve that is located where?
it is a leftward-shifted supply curve
goods with negative externalities
are overproduced
- Government policies to correct negative externalities
- Impose regulations to limit the quantity (e.g., a quota). This will reduce Q* to the socially beneficial QE
- Impose a tax that raises the cost to consumers, which reduces consumption. (as we learned in unit 4, a tax creates a new supply curve called Stax which raises the equilibrium price consumers pay. If the government sets the tax so that Stax is the same as social cost (SC), this is ideal. This is called a Pigouvian tax
a positive network externality makes a social benefit curve that is located where?
shifted demand curve to the right
- Government policies to correct positive externalities:
- Provide subsidies to firms to lower their cost. This makes suppliers create more which shifts the supply curve to the right, so itll reach the social beneficial QE
- Provide subsidies to consumers to increase demand. By subsidizing demand, we reach the socially optimal quantity AND price, much like the Pigouvian tax did with negative externalities. In most countries, cash payments are common, but in Canada, it’s tax credits.
- The government could decide to produce the good itself by establishing a state-owned enterprise and it could subsidize its costs to make it compete with private firms. OR the government could make a state monopoly and supply the entire market at a subsidized rate. Either way, its meant to create a new, right-shifted supply curve Sg that meets the socially optimal quantity QE
whats the issue with supply subsidies and state owned enterprises for fighting positive externalities?
it results in the socially optimal quantity QE, but not the socially optimal price, rather it lands on Psub which is a lower price
types of market failures
- market power
- externalities
- incomplete information
what is a market failure?
markets that shift away from perfect competition
what can the government do about incomplete info?
provide industry standards like food standards to decrease uncertainty and shift the demand curve to the right
Goods can be classified along two dimensions
rivalry, excludibility
rivalrous and excludable
private good
rivalry definition
A good is rivalrous if it is physically consumed when used. A good is non-rivalrous if its use by one person does not diminish the ability of other people to also use the good.
example: pizza is rivalrous, and a TV channel is non-rivalrous as you watching TV doesn’t top others from watching
excludability definition
A good is excludable if a supplier can prevent users from consuming it for free. A good is non-excludable if a supplier cannot stop users from consuming it for free.
do private firms usuallhy provide non-excludable goods?
no, theres no profit
excludable and non-rivalrous
quasi-public good / club good
non-exludable and rivalrous
common property
whats the tragedy of the commons?
Rational people will take as much as they can, leading to overuse of the resource. Consider the problem of overfishing. If too many fish are caught, there won’t be enough fish to make more baby fish for next year’s catch, so everybody is worse off in the long run
non-excludable and non-rivalrous
public good
free-rider problem:
comes up with public goods, since the good is non-excludable and non-rivalrous, a rational person would wait for someone else to produce it rather than producing it themselves.
The role of patents/copyrights is to convert knowledge/intellectual property from a ________ good to a _______ good so the creator can charge for it and will have economic incentives to produce it.
public, club
Club goods usually have __1___. ___2___ and once these ____2___ are passed, they become ______3_____ __4__?
- capacity
- limits
- private
- goods
median voter theorem
the outcome of a majority vote is likely to represent the preferences of the voter who is in the political middle.
A tax is progressive if
people with higher incomes pay a larger share of their income in tax compared to people with lower incomes. AKA progressive taxes take a higher proportion of the wealthy’s income.
What is lobbying?
It’s a form of rent-seeking. Special interest groups ask the government to redirect society resources towards them, so the special interest groups gain while others lose.
governments might impose regulations that are in the best interest of the industry and not the public interest. This is called
regulatory capture
what types of taxes are there?
- Personal income tax: wages, salaries, investment incomes.
- Corporate tax: profits from corporations
- Sales taxes: things like HST
- Property tax: tax on value of land/buildings
sales taxes are?
regressive
Governments attempt to address income inequality in many ways, for example
- Progressive taxes
- Income redistribution like old age security program for low-income seniors and guaranteed income supplement program. Also, cash grants for low/middle-income families with young children.
- Benefits for those who cannot or do not work.
