Introduction to Economic Principles Flashcards
What is economics?
The study of how people interact with each other and with the natural environment in producing their livelihoods
What is positive economic analysis?
The objective study of the economy - what questions
What is normative economic analysis?
The how questions - involving subjective value judgments
What restricts the system of the economy?
Availability of resources (physical for production, time) -> trade-offs
Rapid economic growth caused these 3
- Higher living standards
- Large inequality
- Natural degradation (pollution, climate change)
3 things a capitalist economy needs
- Private property rights (enforced by the state)
- Markets (enough freedom to buy and sell what you want)
- Firms (individuals organizing themselves to produce products and lent money to buy capital goods)
A “laissez faire” economy will create
Inequality and natural degradation
6 roles for the government in modern society
- Redistribute income
- Use expenditures to influence market outcomes directly
- Use norms to influence market outcomes directly (minimum wage)
- Regulation to prevent natural degradation
- Regulation to prevent unhealthy behavior
- Use information campaigns to prevent individuals from taking decisions they’ll later regret
What is opportunity costs?
Choosing something means that you cannot choose something else (=scarcity); the best alternative is called opportunity costs
E.g., if you can either work and earn 50 euros and watch TV at home -> the opportunity cost of watching TV is 50 euros
What is the budget-line?
A line that describes all feasible combinations that can be chosen. Economists assume that individuals will desire a decision on the feasible frontier as it maximizes the trade-off involved
E.g., feasible frontier
What are indifference curves?
A set of lines that describe the preference of the individual - the highest indifference curve representing the highest level of happiness.
E.g., the utility function
What system yields a general efficient allocation of resources?
Competitive markets
4 assumptions of a competitive market
- Property rights are well-defined and secure
- Consumers and suppliers are price takers (do not have market power, so cannot influence price themselves)
- Perfect information (price and quality)
- No entry or exit barriers
If the 4 assumptions of competitive markets hold, what happens?
Prices will signal the social marginal production costs of products. The decision of how much of a product to buy aligns with the trade-off faced by society as a whole
The demand curve reflects
The willingness to pay for the product by consumers
The supply curve reflects
The social marginal production costs of the product
What is the equilibrium?
Where the supply curve meets the demand curve. There is no surplus left, meaning that the consumer pays exactly the price they want, and the firm selling the good does not make a profit, but only covers production costs
Infra-marginal consumers
Pay a price less than their own valuation -> they get a surplus
On a competitive market, producers and consumers cause the surplus to be maximized without…
Government interference
The surplus of all the markets in an economy is a proxy for…
Welfare
If the surplus is not maximized, it is due to
Market failure(s)
What is a common good?
A common good requires collective action, it’s benefits are non-excludable but consumption is somewhat rivalrous (if I get some, you might have a bit less)
6 types of common goods?
- Fair distribution of income
- Fair distribution of wealth
- Quality of local environmental and global climate
- Health and healthy behavior
- Quality of government
- Collective action, dislike of cheating
What is the size of direct taxes compared to indirect taxes (on consumption)?
They are comparable in size
According to the Laffer curve, why does raising the tax not always lead to more tax revenues?
The tax revenue function is an inverted U-shape. If you increase the taxes beyond the middle point of the function, the revenue gains are exactly the same or smaller than a tax before the middle point. Why? The revenues lost due to people not buying a product anymore as it becomes too expensive (and thus government cannot collect taxes on it) is exactly the same or bigger than the increase in tax revenues gained from the increase in tax
When does a higher tax rate yield more taxes?
When the tax rate is on the upward sloping part of the Laffer Curve
What is the tax base elasticity?
With what percentage does the tax base decline when the tax rate increases with 1%?
On the upward sloping part of the Laffer curve, the tax base elasticity…
Is smaller than 1
Economic incidence of a tax might differ from
Statutory incidence (who pays the tax legally)
What is tax incidence?
Analysis of which actors feel the burden of the tax on their real income
Why would suppliers lower their prices if a tax is imposed that is paid by the consumers?
A new tax lowers demand for the product. If suppliers keep charging the original price, they will feel a big drop in demand. Instead, they accept the new reality and lower their price to meet demand -> they start to share in the tax burden
What is a budget-neutral reform?
Replacing a tax with another which yields the exact same revenues as before
E.g., replacing the tax on consumers with a tax paid by producers, but which yields exactly the same amount of revenue
What happens if a tax is introduced that is payable by consumers?
Demand falls -> demand curve goes down
Price received by suppliers is the new equilibrium
Price paid by consumers is the point above the new equilibrium on the demand curve
What happens if a tax is introduced that is payable by the suppliers?
The supply curve shifts up
Price paid by consumers us the new equilibrium
Price received by suppliers is point below new equilibrium on supply curve
What determines the tax incidence?
The relative elasticity of demand and supply! The party that is the least elastic (the most steep slope) will pay the highest share of the tax
