Lecture 2 - Welfare Analysis

Question 1

People think welfare refers to…

Answer 1

Government payments to the poor.

Question 2

To economists, welfare refers to the…

Answer 2

Wellbeing of different groups such as consumers and producers.

Question 3

What do economists mean when they refer to study of welfare analysis?

Answer 3

The impact of change on these different groups’ wellbeing.

Question 4

If we can measure how much more you’d be willing to pay than you actually paid for a product, we’d know…

Answer 4

How much you gained from transaction.

Question 5

What is consumer surplus?

Answer 5

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.

Question 6

What is marginal consumer surplus?

Answer 6

The consumer surplus left to the consumers by purchasing one extra unit of good.

Question 7

What is the producer surplus?

Answer 7

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).

Question 8

The willingness to produce is the…

Answer 8

Marginal cost of producing the good.

Question 9

Producer surplus is closely related to…

Answer 9

Profit.

Question 10

How is total social welfare caluclated?

Answer 10

It is the sum of consumer surplus and producer surplus.

Question 11

What is deadweight loss (DWL)?

Answer 11

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.

Question 12

The reason that competition maximises welfare is that…

Answer 12

Price equals marginal cost at the competitive equilibrium.

Question 13

Consumers value the last unit of output by exactly…

Answer 13

The amount that it costs to produce it.

Question 14

A market failure is inefficient production or consumption, often because…

Answer 14

A price exceeds marginal cost.

Question 15

Welfare is maximised at the…

Answer 15

Competitive equilibrium.

Question 16

What can move us away from that competitive equilibrium?

Answer 16

Government actions.

Question 17

Thus, what can help us predict the impact of various government programs?

Answer 17

Welfare analysis.

Question 18

What are two key policies that shift supply?

Answer 18

• Restricting the number of firms.

- Raising the entry and exit costs.

Question 19

A long run barrier to entry is an…

Answer 19

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.

Question 20

Costs of entry (e.g. fixed costs of building plants, buying equipment, advertising a new product) are not barriers to entry because…

Answer 20

all firms incur them. This is the same for all firms. They all have to pay these.

Question 21

In the short run, exit barriers keep the number of firms…

Answer 21

High.

Question 22

In the long run, exit barriers…

Answer 22

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.

Question 23

What are three specific policies that create a wedge between supply and demand?

Answer 23

• Sales tax.
• Price floor.
• Price ceiling.

Question 24

A new sales tax causes the…

Answer 24

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.

Question 25

What is price floor/minimum price?

Answer 25

The lowest price a consumer can legally pay for a good.

Question 26

Who is it used by and why?

Answer 26

It is often used by the government to protect some producers. For example, agricultural products and farmers.

Question 27

Minimum price is guaranteed by government, but is only binding if…

Answer 27

It is above the competitive equilibrium price.

Question 28

Deadweight loss generate by a price floor reflects two distortions in the market. What are they?

Answer 28

1. Excess production - more output is produced than consumed. Not enough demand.
2. Inefficiency in consumption - consumers willing to pay more for last unit bought than it cost to produce.

Question 29

What is a price ceiling/maximum price?

Answer 29

The highest price a firm can legally change. For example, rent controlled apartments.

Question 30

Maximum price is only binding if it is…

Answer 30

Below the competitive equilibrium price.

Question 31

Deadweight loss may underestimate true loss for reasons. What are they?

Answer 31

1. Consumers spend additional time searching and this extra search is wasteful and often successful.
2. Consumers who are lucky enough to buy may not be the consumers who value it the most (allocative cost).

Question 32

Welfare under free trade serves as…

Answer 32

The baseline for comparison to effects of no trade, quotas and tariffs.

Question 33

What is a tariff?

Answer 33

Essentially a tax on imports.

Question 34

What are the two common types of tariffs?

Answer 34

1. Specific tax - a per unit tax.

2. Ad valorem tariff - a percent of the sales price.

Question 35

What is a quota?

Answer 35

It is a restriction on the amount of a good that can be imported.

Question 36

What is the difference between a tariff and a quota as when analysed graphically, they look similar?

Answer 36

A tariff is a restriction on price, whereas, a quota is a restriction on quantity.

Question 37

You can find a tariff and a quota that generate the same…

Answer 37

Equilibrium.

Question 38

Quotas do not generate any…

Answer 38

Additional revenue for the domestic government.

Question 39

Welfare analysis reveals that tariffs and quotas hurt the importing country, so why do countries continue to use these trade restrictions widely?

Answer 39

• 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.