exam 2 Flashcards
In your own words, briefly define what an externality is
When a third party bears a cost from a market
transaction in which they take no part
Provide an example of a positive and a negative externality not presented in the lecture
notes from class.
positive: good smelling house
negative: bad smelling house
External benefits:
When a third party benefits from a market
transaction in which they take no part
What’s the difference between you eating a sandwich and
sitting in this lecture?
The sandwich is a rival good while the lecture is nonrival
The Law of Demand:
As the price of a good increases, the quantity
demanded falls, ceteris paribus.
Ceteris Paribus:
holding all else constant
Demand Schedule
shows the relationship
between the price level and the quantity
demanded.
The relative price:
the price of a good compared to the price of
other goods.
Law of diminishing marginal utility:
As more units of a good are
consumed, additional units provide less utility.
Consumer surplus:
The difference in the amount consumers are willing to pay and the price they actually pay (also known as the market equilibrium price)
Quantity Supplied:
the amount of a good or service the firm plans
to sell in a given period at a given price.
The Law of Supply
as the price for which a good can be sold
increases, the quantity of that good that is supplied will increase,
ceteris paribus.
Factors affecting supply
- Price of good
- Costs of inputs
- Alternative uses of inputs
- Technology
- Regulation, Taxes
Supply Schedule:
shows the relationship between
the price level and the quantity supplied.
Opportunity Cost of Production:
the total economic
cost of producing a good or service.
• Includes the opportunity cost of all resources,
including those owned by the firm.
• The opportunity cost is equal to the value of the
production of other goods sacrificed as the result of
producing the good.
What factors affect demand?
- Price of good
- Tastes
- Income
- Population
- Prices of other goods (substitutes & complements)
Quantity demanded:
The amount of a good that
individuals want to consume given their income
and prices at a given point in time.
Producer Surplus
The difference between the price suppliers actually receive (market
price) and the minimum price they would be willing to accept. It
measures the net gains to producers and resource suppliers from
market exchange. It is not the same as profit.
The Role of Prices
1. Prices communicate information to decisions makers. 2. Prices coordinate the actions of market participants. 3. Prices motivate economic players.
Economic Efficiency
A situation in which all potential gains from trade have been realized.
Two conditions must be true:
All actions where marginal benefits> marginal cost occur.
All actions where marginal benefits< marginal cost do not occur.
In well-behaved markets, market equilibrium is efficient.
Recall: well-behaved markets ⇒ perfect competition, no externalities, property rights clearly defined, no information asymmetries and trust is present.
Economic Efficiency Graphically:
A situation in which all of the potential gains from trade have been
realized. An action is efficient only if it creates more benefit than
cost. With well-defined property rights and competition, market
equilibrium is efficient.
If P↑ and Q ↑
• Increase in Demand (shift out)
• Causes: ↑ income (normal good), ↑ population, ↑Psubstitute, ↓Pcomplement ,
↑Taste
If ↓ P and ↓ Q
• Decrease in Demand (shift in)
• Causes: ↓ income (normal good), ↓ population, ↓Psubstitute, ↑Pcomplement ,
↓Taste
If P↑ and Q ↓
- Decrease in Supply (shift in)
* Causes: ↑costs (wages, materials), ↓# of producers, ↑Palternative product
If P ↓ and Q ↑
• Increase in Supply (shift out)
• Causes: ↓ costs (wages, materials), ↑ # of producers, ↓ Palternative product
,↑Technology
Price Ceilings & Floors
• Price Floor: Minimum Wage
Asymmetric Information
Occurs when information is held by one, but not all, of the parties involved in a transaction. Examples: 1. Used Car Market. 2. Buying Professional Services. 3. Insurance Market. 4. Financial Markets. 5. Stock Market. 6. Food and Drug Markets.
Why Information Asymmetries are a
concern.
- Over-allocation of resources to production of harmful
products.
2.Adverse Selection
3.Moral Hazard
Rival good
• More consumption by one, means less consumption by others (a limited
# of consumers at a time)
• Examples?
• Food, clothing
Nonrival Goods
• My consumption (or benefits) is not affected by you consuming more
(shared good)
• Examples?
• Air quality, lighthouse, national defense, information
(websites), parks, sporting events, movies
What’s the difference between you spending time at a local
park and attending an UK basketball game?
The basketball game is excludible while the public park (by
design) is nonexcludible
Excludible Good
• Possible to limit consumption and prevent individuals from consuming
(Can charge a price)
• Examples?
• Food, clothing, sporting events, movies
