Intro Flashcards
Economic assumptions to markets
- Perfect competition.
- Rational actors.
- Full information.
- Homogenous product
Aggregate demand
The sum of all individual demand curves
Demand - A price increase results in
movement on the demand curve - the demand changes but the curve stays the same
Aggregate supply
Sum of all individual supply curves
Excess supply
the area above the equilibrium -> Producers produce for a price no one is WTP
Excess demand
The area below the equilibrium - No producer is WTS at price below eq
efficiency
maximizing utility of all market participants
distribution
Distribution of resources and fairness Depends, e.g., on property rights and initial distribution of resources.
Pareto efficiency
A situation which no party can be made better off without another party being worse off
Pareto improvement
At least one party can be made better off and no other party will be worse off
Consumer surplus
Area below the demand curve and above the price
- > The amount that customers are WTP - the actual price in the market
- > Reflects customers utility
Producer surplus
Area below the price and above the supply function
-> Price paid to the produced - production costs
Total welfare in the market =
CS+PS
Deadweight loss DWS
loss in welfare to perfect competition
Perfect competition vs monopoly
Perfect competition: producers produce at marginal cost,
price as givenMonopoly: producer produces at marginal revenue, price set
by monopolist
Elasticities are useful measure informing about
how suppliers and
consumers react to changes in the market (e.g., prices).
Elasticities
- Elasticity of demand (price elasticities, income elasticities)
- Elasticity of supply (price elasticity)
Price elasticity of demand
Measures how demand changes if the p increases by 1 unit
= the % change in demand quantity / % change in price
Perfectly inelastic demand
Elasticity = 0
An increase in p leaves the quantity demanded unchanged
Inelastic demand
Elasticity < 1
A 22% increase in price leads to an 11% decrease in quantity demanded
Unit elastic demand
Elasticity = 1
A 22% increase in p leads to 22% decrease in quantity demanded
Elastic demand
Elasticity > 1
A 22% increase in p leads to 67% decrease in quantity demanded
Perfectly elastic demand
Elasticity equals infinity
At any p > $4, quantity demanded = 0,
at exactly $4, customers will buy any quantity
At p < $4, quantity demanded is infinite
Cross price elasticities of demand
CPED = & change of quantity of good 1 / % change of p for good 2
if + : goods are substitutes
if - : goods are complements
if 0: goods are independent
Perfectly inelastic demand
Elasticity = 0
An increase in p, leaves the quantity supplied unchanged
Inelastic supply
Elasticity < 1
A 22% increase in p leads to a 10% increase in quantity supplied
Unit elastic supply
Elasticity = 1
A 22% increase in p, leads to a 22% increase in Q supplied
Elastic supply
Elasticity > 1
A 22% increase in p leads to 67& increase in Q supplied
Perfectly elastic supply
Elasticity equals infinity
At any p > $4, Q is infinite
At exactly $4, producers will supply and Q
At p < $4, Q=0
Why do we have regulatory interventions
Market failure (efficiency criteria):
• No existing market.
• Incomplete competition (e.g., monopoly).
• Externalities.
• Public goods.
• Incomplete information, transaction cost.
Equality criteria (social justice):
• Equal distribution of wealth.
• Redistribution
• Allocation of property rights.
What are the regulatory interventions
• Interventions targeted at prices.
- > Maximum price.
- > Minimum price.
• Taxes.
- > To generate public income.
- > To steer and influence market outcomes.
• Subsidies.
- > To increase income of certain groups.
- > To increase the supply/demand of certain goods.
Minimum price
State sets min Ps, resulting in excess demand Qg, and to keep Ps, the state needs to buy Qg
Consequences for consumers and suppliers:
Consumer surplus is reduced
Producer surplus increases
Welfare loss: D - (Q2-Q1)Ps
Potential savings for society: (Q2 - Q1)Ps- D
Taxes
Direct
and
Indirect
Direct taxes
Collected directly at the taxpayer: income tax, earnings tax, inheritance tax
Indirect taxes
Collected with the sale from goods and services: VAT, Fuel duty, CO2 tax, Dividend tax
Price inelastic demand means that
buyers have few alternatives to the product
Price inelastic supply means
producer dont have good alternatives
Subsidies
The opposite of a tax.
A subsidy for the producer reduces production cost.
Subsidies change market equilibria.
Subsidies allow consumers to pay lower prices and producers to pay
lower production cost.
Consumers and producers benefit from subsidies.
But they might also lead to a DWL.
Externalities
Uncompensated effects of economic decision making on the
wealth of independent third parties
Are usually not included in the economic decision making
process of parties.
Are a form of market failure.
Consequence: inefficient allocation of resources and welfare losses
Negative externalities
− Emmisions
− Cigarette smoke
− Dogshit on the street
− Loud music
Positive externalities
− Scientific discoveries
− Renovating of historic buildings
− Planting trees
Coase theorem
under ideal economic conditions,
where there is a conflict of property rights, the involved parties can
bargain or negotiate terms that will accurately reflect the full costs and
underlying values of the property rights at issue, resulting in the most
efficient outcome.
Allocation of property rights.
Private negotiations.
Trade (of C02 certificates, e.g.,)
Coase theorem May not always work, because of
transaction cost,
asymmetric information, bargaining power, free-rider
problems
