Lecture 2 - Welfare Analysis Flashcards
People think welfare refers to…
Government payments to the poor.
To economists, welfare refers to the…
Wellbeing of different groups such as consumers and producers.
What do economists mean when they refer to study of welfare analysis?
The impact of change on these different groups’ wellbeing.
If we can measure how much more you’d be willing to pay than you actually paid for a product, we’d know…
How much you gained from transaction.
What is consumer surplus?
The monetary difference between the maximum amount that a consumer is willing to pay for the quantity of the good purchased and what the good actually costs.
What is marginal consumer surplus?
The consumer surplus left to the consumers by purchasing one extra unit of good.
What is the producer surplus?
The difference between the amount for which a good sells (market price) and the minimum amount necessary for sellers to be willing to produce it (marginal cost).
The willingness to produce is the…
Marginal cost of producing the good.
Producer surplus is closely related to…
Profit.
How is total social welfare caluclated?
It is the sum of consumer surplus and producer surplus.
What is deadweight loss (DWL)?
The name for the net reduction in welfare from the loss of surplus by one group that is not offset by a gain to another group. Intuitively, it is the social welfare that goes to no one.
The reason that competition maximises welfare is that…
Price equals marginal cost at the competitive equilibrium.
Consumers value the last unit of output by exactly…
The amount that it costs to produce it.
A market failure is inefficient production or consumption, often because…
A price exceeds marginal cost.
Welfare is maximised at the…
Competitive equilibrium.
What can move us away from that competitive equilibrium?
Government actions.
Thus, what can help us predict the impact of various government programs?
Welfare analysis.
What are two key policies that shift supply?
- Restricting the number of firms.
- Raising the entry and exit costs.
A long run barrier to entry is an…
Explicit restriction or a cost that applies only to potential new firms (e.g. large sunk costs - unavoidable costs). It indirectly restricts the number of firms entering. Barriers to entry are invented by the government sector.
Costs of entry (e.g. fixed costs of building plants, buying equipment, advertising a new product) are not barriers to entry because…
all firms incur them. This is the same for all firms. They all have to pay these.
In the short run, exit barriers keep the number of firms…
High.
In the long run, exit barriers…
Limit the number of firms entering. Once you enter the market, it may be hard to leave. You may not even enter in the first place because the market is not profitable.
What are three specific policies that create a wedge between supply and demand?
- Sales tax.
- Price floor.
- Price ceiling.
A new sales tax causes the…
Price that consumers pay to rise and the price that firms receive to fall. The former results in lower CS. The latter results in lower PS.
What is price floor/minimum price?
The lowest price a consumer can legally pay for a good.
Who is it used by and why?
It is often used by the government to protect some producers. For example, agricultural products and farmers.
Minimum price is guaranteed by government, but is only binding if…
It is above the competitive equilibrium price.
Deadweight loss generate by a price floor reflects two distortions in the market. What are they?
- Excess production - more output is produced than consumed. Not enough demand.
- Inefficiency in consumption - consumers willing to pay more for last unit bought than it cost to produce.
What is a price ceiling/maximum price?
The highest price a firm can legally change. For example, rent controlled apartments.
Maximum price is only binding if it is…
Below the competitive equilibrium price.
Deadweight loss may underestimate true loss for reasons. What are they?
- Consumers spend additional time searching and this extra search is wasteful and often successful.
- Consumers who are lucky enough to buy may not be the consumers who value it the most (allocative cost).
Welfare under free trade serves as…
The baseline for comparison to effects of no trade, quotas and tariffs.
What is a tariff?
Essentially a tax on imports.
What are the two common types of tariffs?
- Specific tax - a per unit tax.
2. Ad valorem tariff - a percent of the sales price.
What is a quota?
It is a restriction on the amount of a good that can be imported.
What is the difference between a tariff and a quota as when analysed graphically, they look similar?
A tariff is a restriction on price, whereas, a quota is a restriction on quantity.
You can find a tariff and a quota that generate the same…
Equilibrium.
Quotas do not generate any…
Additional revenue for the domestic government.
Welfare analysis reveals that tariffs and quotas hurt the importing country, so why do countries continue to use these trade restrictions widely?
- Domestic producers stand to make large gains from such government actions, so they organise and lobby the government effectively to implement such policies.
- These efforts and expenditures to gain a rent (or profit) from government action are called rent seeking behaviours.
- Although losses to all consumers are quite large, losses to any single consumer are usually small, so consumers rarely lobby against trade restrictions. It can also cost a lot, so it is not something consumers are willing to do.
