IV.A-D Exam Flashcards
what is the free market
- little govt involvement in the economy
- individuals own resources and determine what to produce, how to produce, and who gets it
- the opportunity to make profit gives people incentive to produce quality items efficiently
- wide variety of goods available to consumers
- competition and self-interest work together to regulate the economy
the govts job is to ____, _____,______
enforce contracts
secure property rights
defend the country
what is the invisible hand
The unobservable market force that helps the demand and supply of goods in a free market to reach equilibrium automatically is the invisible hand
what is a market failure?
a situation in which the free-market system fails to satisfy society’s wants
(when the invisible hand doesn’t work)
-private markets do not efficiently bring about the allocation of resources
what is the result of a market failure?
govt must step in to satisfy society’s wants
what are the four market failures?
- public goods
- externalities
- monopolies
- unfair distribution of income
in each of the market failures the govt steps in to….
allocate resources efficiently
why must the govt provide public goods and services?
-it is impractical for the free-market to provide these goods because there is little opportunity to earn profit
what is the free-rider problem
individuals that benefit without paying
what is wrong with free riders?
- keep firms from making profits
- left to the free market, essential services would be under produce
how can government solve the free rider problem?
- find new ways to punish free-riders
2. use tax dollars to provide the service to everyone
to be considered public goods what 2 criteria should it meet?
- nonexclusion
- everyone can use the good
- cannot exclude people from enjoying the benefit (such as a sunset) - shared consumption (nonrivalry)
- one person’s consumption of a good does not reduce the usefulness to others
why doesn’t the free market provide public goods?
there is little opportunity to earn profit because there are plenty of free riders
how does the govt determine what quantity of public goods to produce?
-they use supply and demand
demand for public goods
the marginal social benefit of the good determined by citizens willingness to pay
supply of public goods
the marginal social cost of providing each additional quantity
true or false:
demand = MSB
true
true or false:
supply = MSC
true
what is an externality
when external benefits or external costs are on someone other than the original decision maker
what are externalities market failures?
the free market fails to include external costs or external benefits
why does the graph for negative externality have two supply curves?
- private cost
2. social cost
why does the graph for positive externality have two demand curves?
- private benefit
2. social benefit
with no govt involvement (when it comes to externalities) there would be too much of ____ and too little of _____
- some goods
- others
when the quantity made for the free market is bigger than the quantity needed for optimum social benefit what does this mean?
overallocation
what can the govt do to fix a neg externality (when the supply curve moves)
-put a per unit tax
when the quantity made for the free market is less than the quantity needed for optimum social benefit what does this mean?
underallocation
what can do to fix when there is positive externality (when the demand curve moves)
-subsidy
the tragedy of the commons
- goods that are available to everyone (air, oceans, etc)
- there is no monetary incentive to use them efficiently
- result is high spillover costs
antitrust laws
laws designed to prevent monopolies and promote competition
why are monopolies market failures?
-monopolies destroy the key ingredient of the free market system (competition)
taxes
mandatory payments made to the govt to cover costs of governing
what are the two purposes of of taxes?
- finance govt operations
- public goods (highways, defense)
- fund programs (welfare, social security) - influence economic behavior of firms and individuals
- ex) excise taxes on tobacco raises tax revenue and discourages use of cigarettes
what does the laffer curve show
the relationship between tax rate and tax revenue
if the govt increase taxes rates tax revenue will ____
increase
if the tax rate becomes too high, tax revenue will ____
fall since workers have no incentive to work harder
how do you calculate marginal social benefit
MSB = MPB + MEB (marginal external benefit)
how do you calculate marginal social cost
MSC = MPC + MEC (marginal external cost)
society wants a market to produce the quantity where ….
MSB = MSC
private decision makers want to have the quantity where…
MPB = MPC
what is ability to pay theory
The ability-to-pay principle in taxation maintains that taxes should be levied according a taxpayer’s ability to pay. This progressive taxation approach places an increased tax burden on individuals, partnerships, companies, corporations, trusts and certain estates with higher incomes.
what is benefits received principle?
The benefit principle is a concept in the theory of taxation from public finance. It bases taxes to pay for public-goods expenditures on a politically-revealed willingness to pay for benefits received.
what is an excise tax?
Excise taxes are taxes paid when purchases are made on a specific good, such as gasoline. Excise taxes are often included in the price of the product. There are also excise taxes on activities, such as on wagering or on highway usage by trucks.
what does inelastic demand mean?
DEFINITION of ‘Inelastic’ An economic term used to describe the situation in which the supply and demand for a good or service are unaffected when the price of that good or service changes.
what does elastic demand mean?
DEFINITION of ‘Elasticity’ A measure of a variable’s sensitivity to a change in another variable. In economics, elasticity refers the degree to which individuals (consumers/producers) change their demand/amount supplied in response to price or income changes.
the government should do things for society as long as MSB >
MSC
coase theorem
The Coase Theorem is essentially what we discussed in the PowerPoint, although I didn’t use the name, about how companies can decide to work together on solving those market issues regarding the woodpeckers or the pollution of the lake. It is when owners/individuals handle problems by compromising amongst themselves. It is not something you need to be overly concerned about.
