Final Deck Flashcards
Define Economic Value
*Must be valued either directly or indirectly by humans *Measured in terms of tradeoffs - what is the maximum one would be willing to give up (willingness-to-pay) in terms of – money; time; other goods *
Why Is The Supply Curve Upward Sloping?
*Costs money to produce something new, so as you create new things its going to increase the amount your spending
Under Competitive Market Conditions, The Producer Gets One Price For All Units of Production
TOTAL REVENUE
TOTAL REVENUE = PRICE * QUANTITY
The Total Cost of Production
The Producer Surplus
PROFIT
Consumer Surplus
Consumer Surplus = Total Willingness To Pay - Cost
Total WTP
Add Up the Marginal Willingness-To- Pay = Total WTP
Total Cost
Add up the Marginal Costs to Consumers = Total Cost
Consumer Surplus
Consumer Surplus = Total WTP-Cost
How Do We Know This Market Outcome is Best = Highest Value to Society?
Pareto Efficient
*An economic outcome is Pareto Efficient if there is no way to make any person better off without hurting anybody else.
*The competitive market determines a Pareto efficient amount of output because at Q* the price that someone is willing to pay to buy an extra unit of the good is equal to the price somebody must be paid to sell an extra unit of the good.
Example: calculating Producer Surplus
• Base of the triangle = $20-$2 = $18
- Height of the triangle = 100
- Area = 1⁄2 base X height
- Producer Surplus = $900
Taking Into Account the Cost of the Externality on the demand and cost of a product
Taking Into Account the Cost of the Externality Shifts the Supply Curve Up
Example: Whats the change in producer surplus taking into account the externality shift?
Find the area of the new triangle and subtract the bigger triangle from the smaller triangle. Youll usually end up with a negative number.
• New Producer Surplus:
– New Base =$24-$3.20 = $20.80
– New Height = 80 bushels
– Note less produced at a higher cost – New PS = $832
• Change in PS = $832-$900 = -$68
Whats the change in consumer surplus taking into account the extrnality factor?
Results of externality factors
Including some of the harm from the pollution externality into the market resulted in:
– Less being produced
– At a higher price
– Consumers are clearly always worse off
– Producers are usually worse off unless price goes up a real lot.
Need to know: Economic Definition of Value
– Willingness-to-Pay
– Producer and Consumer Surplus
• Calculate using simple geometry (1⁄2 b X h) • Calculate CHANGE in value
Need to know: Economic definition of externality
DEFINITION OF ‘EXTERNALITY’
A consequence of an economic activity that is experienced by unrelated third parties. An externality can be either positive or negative.
Pareto improvement:
A change in conditions (policy, allocation of resources, etc.) that leaves some individuals or groups better off and all other individual or groups at least as well off as they were before the change
Pareto efficient (Free market outcome w/o externalities):
– No additional change can be made that is a Pareto
improvement.
– Example (the sale of a used car): The seller value the car at $15,000, while the buyer is willing to pay $20,000 for it. A deal in which the car is sold for $17,500 would be Pareto improvement since both the seller and the buyer are better off as a result of the trade.
Policy Outcomes
Pareto improvements are win-win situations.
However, most policy changes create some winners and some losers.
Even a market exchange will not be a Pareto improvement in there are external costs (i.e. pollution).
Thus, the Pareto criterion usually can’t tell us whether one policy is “better” than another.
We need another way to compare outcomes. (Kaldor Hicks)
(Kaldor-Hicks) Compensation Principle:
Some groups (individuals) are made worse off (losers) and some are made better off (winners). But the amount that the winners gain is more than the amount the losers lose. The winners could compensate the losers.
– The decision on whether or not to actually use gains to compensate the losers is a political decision, not an economic decision.
Policy Outcomes: example
- Under policy X: Waterman A is allowed to catch 10 bushels of crabs, waterman B is allowed to catch 100 bushels of crabs.
- Under policy Y: Waterman A is allowed to catch 20 bushels of crabs, waterman B is allowed to catch 99 bushels of crabs.
- The adoption of policy Y would not be Pareto improvement, since waterman B is now worse off.
- It would be a Kaldor–Hicks improvement, as waterman A could give waterman B anywhere between 1 and 10 bushels to accept this alternative situation.
