Lecture 1: Fundamentals

Question 1

What is positivistic economics?

Answer 1

Aims to describe what was and what is (sometimes: what will be)
- E.g. What are the costs and benefits of reducing emissions?
- E.g. How much does demand ↓ if the price ↑

Question 2

What is normative economics?

Answer 2

Deals with what ought to be from a broad welfare perspective
- E.g. How much pollution should be allowed?
- E.g. Are market outcomes desirable, and if not, how can we correct?

Question 3

What are total benefits?

Answer 3

sum of all benefits from carrying out an activity

Question 4

What is the marginal benefit?

Answer 4

the increase in total benefit that results from
carrying out one additional unit of an activity
▪ Often measured as maximum willingness to pay by consumers

Question 5

What are the total costs?

Answer 5

sum of all costs from carrying out an activity

Question 6

What are the marginal costs?

Answer 6

the increase in total cost that results from carrying
out one additional unit of an activity
▪ Often measured as financial and/or opportunity costs

Question 7

What is the theory of Adam Smith (1776)?

Answer 7

maximization of individual welfare contributes to maximization of social welfare.

Question 8

According to Adam Smith (1776), how take competitive markets care of an efficient allocation of scarce means through prices? (Name 3)

Answer 8

▪The sum of consumer and producer surplus is maximal;
▪or the marginal costs of production equal the marginal benefits;
▪private costs and benefits equal social costs and benefits.

Question 9

What is consumer surplus?

Answer 9

The difference of the actual price and what the consumer is willing to pay. E.g. the consumer is willing to pay 5€ for a beer, but it only costs 3€, then the consumer surplus is 2€.

Question 10

What is producer surplus?

Answer 10

Difference between costs of production and selling price. E.g. the beer costs 0,50€ to produce and is getting selled for 3€, the. 2,50€ is the producer surplus (“his profit”)

Question 11

What is reflected by slope of the demand curve?

Answer 11

Slope reflects the price elasticity of demand:
• “The % change in quantity demanded that occurs in
response to a 1% change in the price”
The higher the price elasticity of demand, the flatter the demand curve

Question 12

Name examples for high elasticity of demand.

Answer 12

-bread
-soup
-paper
-water
-flour

Question 13

Name examples of low elasticity of demand.

Answer 13

-petrol
-iPhone
-laptop
-cigarettes
-soda

Question 14

Why is supply curve upward sloping?

Answer 14

Increasing marginal costs of production
• Short run: Law of diminishing returns (decrease in marginal (incremental) output of a production process as the amount of a single factor of production is incrementally increased, holding all other factors of production equal)
• Medium run: In a competitive market the most productive firms produce
first

Results in an upward sloping supply curve
• The market (firms) supplies more if the price is higher

Slope reflects the price elasticity of supply
• “The % change in quantity supplied that occurs in response to a 1% change in the price”.
• The higher this elasticity of supply, the flatter the supply curve

Question 15

How to calculate welfare or net social value?

Answer 15

sum of consumer and producer surplus

Question 16

What are the 3 methods of GDP calculation?

Answer 16

• Income Method (Labours, rent, profit of private sector businesses)
• Expenditure Method (Net Exports, consumption/government/investments expenditure)
• Output Method (value added from : Agriculture, Service, Manufacturing)

Question 17

how much production/pollution is optimal and when to stop?

Answer 17

Marginal analysis gives the answer:
• Continue producing/polluting until MB = MC, because this maximizes
net total benefits (= total benefits - total costs)
- If MB > MC it makes economic sense to produce more; - If MC > MB it makes economic sense to produce less.

Question 18

Private markets result in socially optimal production levels only if:

Answer 18

Private marginal costs and benefits = Social marginal costs and benefits

BUT THIS IS ALMOST NEVER THE CASE BECAUSE OF EXTERNALITIES

Question 19

What is an externality?

Answer 19

• An externality is the unintended effect of a decision of actor A on actor B, without actor B being involved or fully represented in the decision.
• Externalities refer to unintended effects: pestering and charity do not generate externalities, these are intended actions!

Question 20

How are marginal social costs calculated?

Answer 20

Marginal private costs + marginal external costs

Question 21

What is the net cost of an externality?

Answer 21

Dead Weight Loss (DWL)

Question 22

Provide the definition of DWL

Answer 22

Net loss of economic efficiency / welfare that occurs when the socially optimal quantity of production of a good or service is not achieved (may hold for positive and negative externalities)

Question 23

Examples of market failure

Answer 23

• externalities
• imperfect competition / (natural) monopolies
• transaction costs
• Public goods (free riding)
• Ill-defined property rights

Question 24

What is a public good?

Answer 24

A public good is a good that is characterized by non- rivalry and non-excludability
a)
Non-rivalry means that consumption of the good by one individual does not reduce availability of the good for consumption by others
b)
Non-excludability means that no one can be excluded from using the good

Question 25

What are the 4 types of goods? And what is the degree of non-rivalry and non-excludability?

Answer 25

Club goods (problem: natural monopolies) —> high non-rivalry/low non-excludability
Public good (problem: underprovision) —> high non-rivalry/high non-excludability
Private goods —> low non-rivalry/low non-excludability
Common goods (problem: overextraction) —> low non-rivalry/high non-excludability

Question 26

Name the 3 aspects for an efficient property rights structure:

Answer 26

1. Exclusivity: owner bears all costs and benefits, unless sale to others occurs
2. Transferability: Rights are fully transferable on voluntary basis
3. Enforcability: Rights are secure (no involuntary seizure by others)

Question 27

What are transaction costs?

Answer 27

Definition: full costs of an exchange / participate in market, including costs of information

Example: Transaction costs of emissions trading
• Establishing the scheme
• Brokers who facilitate trade have costs
• Prep/monitoring costs are incurred by participants

Question 28

What is the analysis of costs and benefits for?

Answer 28

To judge desirability of actions/policies

Question 29

How to attain optimality?

Answer 29

Optimality is attained if marginal costs = marginal benefits

Question 30

How can markets result in Optimal outcomes for society?

Answer 30

no market failures