microeconomics Flashcards
1
Q
consumer def
A
= people and organizations who buy goods and services in a market
2
Q
producer def
A
= people and organizations that make, grow and/or supply goods, services and resources in a market
3
Q
market def
A
= a collection of firms, each of which is supplying products that have some degree of substitutability to the same potential customers
4
Q
division of markets
A
- product market ⇒ goods and services are sold
- factor market ⇒ resources are sold
- labour market ⇒ people offer their services in exchange for a salary
- financial market ⇒ foreign currencies, company shares and other financial contracts are traded
5
Q
competition
def, occurs when
A
= striving against others to reach an objective, involves one firm trying to take away market share from another
occurs when a large number of buyers and sellers act individually
6
Q
degree of competition
A
perfect competition => monopolistic competition => oligopoly => monopoly => pure monopoly
7
Q
degree of competition is classified by
A
- number of sellers and buyers
- nature of product
- freedom of entry to industry
- knowledge, information available on the produced good
8
Q
demand def
A
= the quantity of a good or service a consumer is willing and able to purchase at various price
9
Q
demand curve
A
= the relationship between the price of a good and the quantity demanded, holding all other variables constant
a downwards-sloping curve => price is inversely proportional to quantity
changes in price cause movement along the curve
10
Q
why the demand curve is a curve
A
- the law of diminishing marginal utility
- real income effect
- substitution effect
11
Q
substitution effect
A
if the price of a good rises, consumers will buy less of that good, more of others
12
Q
real income effect
A
if the price of a good rises, the real income of consumers fall and are able to buy less
13
Q
the law of diminishing marginal utility
A
the marginal utility of each consecutively used good diminishes, as a result of the gradual satisfaction of a need
utility cannot be measured, however, this theory assumes that it is in fact quantifiable ⇒ utility = [util]
14
Q
shifts of the demand curve
A
- changes in non-price determinants of demand ⇒ shift
- increase in demand ⇒ shift to the right
- decrease in demand ⇒ shift to the left
15
Q
non-price determinants of demand
A
consumer incomes
preferences (influenced by fashion, advertising, publicity, …)
price of other goods (substitutes, complements, unrelated goods)
future price expectations
number of customers
other changes in income distribution, government policies
changes of needs (weather, pandemics, …)
16
Q
“demand” vs “quantity demanded”
A
“demand” ⇒ entire demand curve, the function
“quantity demanded” ⇒ a specific quantity, a number
17
Q
normal and inferior goods
A
normal goods ⇒ demand increases as people’s incomes increase
inferior goods ⇒ demand decreases as people’s incomes increase
18
Q
substitute and complementary goods
A
substitute goods ⇒ goods with similar characteristics and uses for consumers
complementary goods ⇒ goods that are consumed together
19
Q
supply def
A
= the amount a firm is willing and able to sell over a certain period of time at a certain price
price is directly proportional to quantity supplied
20
Q
why the supply curve is a curve
A
law of diminishing marginal returns
increasing marginal costs of production
21
Q
increasing marginal costs of production
A
costs of production increase as output increases → producers are ready to increase quantity supplied if they can receive higher price in the market for it that would cover the additional costs
22
Q
law of diminishing marginal returns
A
an additional factor of production produces a lower increase in output than the previous added factors of production
23
Q
non-price determinants of supply
A
- cost of factors of production
- price of related goods, complements
- government intervention
- future price expectations
- state of technology
- weather (agriculture, infrastructure, …)
- supply shocks
- number of firms (more firms ⇒ higher supply in the market)
- expected price
24
Q
change in price ⇒
increased supply ⇒
decreased supply ⇒
to the supply curve
A
change in price ⇒ movement along the supply curve
increased supply ⇒ shift to the right
decreased supply ⇒ shift to the left
25
supply shock
= cuts in major input supplies ⇒ decrease in supply ⇒ supply curve shifts to the left
26
joint supply
two or more goods are derived from the same product
impossible to produce more of one without producing more of the other ⇒ increase in quantity supplied of one product causes the increase in quantity supplied of the other
f.i. animal products
27
competitive supply
the production of two goods use similar resources and processes
increase in production of one good ⇒ decrease in production of the other (ceteris paribus)
28
market equilibrium
| def, achieved how, tendency of prices
supply = demand (QS = QD)
in a free market is achieved with the regulation of prices
prices have no tendency to change
29
in a free market, prices act as:
1. a signal ⇒ what and how much should be produced
1. an incentive to reallocate resources ⇒ motivation for consumers to bring a market to equilibrium
1. a rationing device ⇒ for who are products produced for
30
price as a signal in a free market
* signals what and how much should be produced
* rising prices signal to consumers that they should consume less, or to producers that they should make more
* declining prices signal to consumers that they should consume more of a product, to producers that they should make less
31
price as an incentive in a free market
* an incentive **to reallocate resources** ⇒ motivation for consumers to bring a market to equilibrium
* rising price ⇒ consumers will buy less and reallocate their resources to other products, producers will reallocate their resources to create more of the product
* falling price ⇒ consumers will buy more and reallocate their resources to the product, producers will reallocate their resources to create more of other product
32
price as a rationing device
a rationing device for who products are produced for in shortages, when resources are scarce
price as a rationing device isn’t necessary equitable
33
states of disequilibrium
1. surplus = excess of supply (QS > QD) ⇒ fall of price
1. shortage = excess of demand (QD > QS) ⇒ rise in price
34
how does a graph look when supply is limited? demand?
Supply is limited ⇒ supply is a vertical line
Demand is limited ⇒ demand is a vertical line
35
productive vs allocative efficiency
| def, on a graph
**Productive** efficiency ⇒ producing goods using the **fewest possible resources, lowest possible cost** → resources aren’t wasted and average production cost is low (MC = AC)
**Allocative** efficiency ⇒ producing **optimal combination of goods**, benefits of consuming these goods are maximised for the whole society and no one is harmed (MC = D)
36
individual consumer, producer surplus
* Consumer surplus ⇒ highest price customers are willing and able to purchase a good for – actual price
* Producer surplus ⇒ lowest price producers are willing and able to offer the good – actual price
37
coefficients of elasticity of demand and supply
PED (price elasticity of demand)
PES (price elasticity of supply)
YED (income elasticity of demand)
XED (cross elasticity of demand)
38
PED
PED = a measure that indicates the degree of consumer response to a change in price
always negative
PED = ∆Q(demanded)/∆P
steeper demand curve ⇒ less elastic demand
39
|PED| > 1
price-elastic demand (change in price causes a proportionally greater change in quantity demanded)
40
|PED| < 1
⇒ price-inelastic demand (change in price causes a proportionally smaller change in quantity demanded)
41
|PED| = 1
good is unitarily price-elastic (change in price causes a proportionally equal change in quantity demanded)
42
PED = 0
perfectly inelastic demand (a change in price causes no change in quantity demanded)
a straight vertical line
43
PED = ∞
perfectly elastic demand (quantity demanded is infinite, a slight raise in price will cause a fall in demand to zero)
straight horizontal line
44
determinants of PED
* **availability of substitutes** → more available substitutes ⇒ price is more elastic
* **narrowness of market** → more narrowly defined good ⇒ easier to find substitutes ⇒ price is more elastic
* **necessity vs luxury** → the more “necessary” ⇒ harder to find substitutes ⇒ price is more inelastic
* **time horizon** (demand is more elastic in the long run)
* **proportion of income spent on the good** (small proportion of income is spent on the good ⇒ more inelastic)
45
demand elasticity and total revenue
* **inelastic** ⇒ optimal to **raise prices** for greater TR
* **elastic** ⇒ optimal to **lower prices** for greater TR
46
PES
| formula, pos/neg, steepness,
* price elasticity of supply
* PES = ∆Q(supplied)/∆P
* always positive
* steeper curve ⇒ less elastic supply
* primary commodities generally have relatively lower PES than manufactured goods as it takes longer for them to increase production
47
PES > 1
| + graph
elastic (a change in price leads to a proportionally greater change in quantity supplied, producers are sensitive to price changes)
graph passes through the y-axis (price)
48
PES < 1
inelastic (a change in price leads to proportionally greater change in quantity supplied, producers are relatively insensitive to price changes)
graph passes through the x-axis (quantity)
49
PES = 1
| +graph
unitary elastic supply (a change in price leads to an equal change in quantity supplied, producers are proportionally sensitive to price changes)
graph passes through the origin
50
PES = 0
perfectly inelastic supply (a change in price leads to no change in quantity supplied, supply is unresponsive to price and producers are not sensitive to price changes)
graph is a straight vertical line
51
PES = ∞
perfectly elastic supply (a small change in price would lead to an infinite change in supply)
52
determinants of PES
* **time horizon** (more elastic in the long run)
* **flexibility** and cost of factors of production (more flexible factors of production ⇒ more responsive a firm can be to changes in price ⇒ greater PES)
* **unused capacity** (firm is using its maximum capacity ⇒ more difficult and costly to increase production ⇒ PES is smaller)
* ability to **store** stock (a firm has the ability to store stock⇒ supply can be more responsive to change ⇒ greater PES)
53
PES of perishable goods
only non-perishable goods can be stored ⇒ PES is usually lower for perishable goods
54
income elasticity of demand
YED = ∆Q(demanded)/∆Y
Y ... income
55
YED of normal, inferior, luxury goods and necessities
normal goods ⇒ YED > 0
inferior goods ⇒ YED < 0
luxury goods ⇒ YED>>0
necessity ⇒ 0 < YED < 1
56
|YED| > 1
income elastic demand
57
|YED| < 1
income inelastic demand
58
cross elasticity of demand
⇒ percentage change in quantity demanded of one good caused by a 1% change in price of another good
XED = ∆Q(A)/∆P(B)
59
when are two goods substitutes?
| elasticity of demand
XED > 0
60
when are two goods complements?
| elasticity of demand
XED < 0
61
purposes of government intervention
* earn revenue for the government (taxes)
* to support firms, households with low incomes
* to influence levels of production
* to help consumers make better choices
* to correct market failure
* to promote equity and redistribute income
* to promote sustainability
62
how do governments help consumers make better choices
indirect taxes to reduce quantity of a product
min prices to increase prices of demerit goods
subsidies on healthy products
63
how do governments promote equity and redistribute income?
minimum wage and prices for fair pay
max prices on necessities
64
how do governments promote sustainability?
* **indirect taxes** to reduce quantity of products that threaten sustainability
* **subsidies** to products that are favourable to the environment or consumer
65
forms of government intervention
* taxation
* subsidies
* price control (price ceilings, floors)
66
aims of taxation
* collect government revenue
* discourage consumption of demerit goods
* redistribution of income
* correct inefficient allocation of resources
* governments may use tax revenue to provide public goods, infrastructure, education, healthcare
67
indirect vs direct tax
Indirect tax = a tax imposed on a good or service, typically paid to the government, considered a cost of production (VAT, excise, …)
Direct tax = a tax paid directly to the government (income tax)
68
GST or VAT
GST (goods and services tax) = VAT (value added tax) = a tax on goods and services at every stage in the production process where value is added
69
excise tax
= a tax imposed on certain goods and services (tobacco, nicotine, alcohol, …), imposed primarily on demerit goods
70
specific tax
= a fixed amount of tax imposed on a good or service per unit sold
71
percentage (ad valorem) tax
= a fixed percentage charged on the selling price of the good
72
effect of taxes on different stakeholders
* **consumers** ⇒ pay more and consume less
* **producers** ⇒ sell less at a lower final price
* **government** ⇒ gains revenue from tax, which can be spent on public goods and services
* **workers** ⇒ market is smaller → less output → fewer workers are needed → higher unemployment
73
effects of taxation
* **welfare** effect (burden of tax on producer and consumer) = tax yield – cost of the tax
* **distortion** of the market
* influence on **behaviour**
* creation of **black markets**
* increased **business costs**
* raises **government revenue** to pay for public goods and services
74
elasticity of demand and supply after taxes
* more **inelastic** demand and supply ⇒ **larger tax burden**
* **demand** is more inelastic than supply ⇒ **consumers** pay more than producers
* **supply** is more inelastic than demand ⇒ **suppliers** will pay the higher burden
75
subsidies
= per-unit payments to producers to lower production costs and increase output, form of government intervention
given to the producer of a good, with no obligation to return it
76
purposes of subsidies
* **lower production costs** in order to **lower prices** to make basic necessities and merit goods more **affordable** to low-income households
* promotion of **redistribution of income** and **competition** between producers
* **encourage consumption** of goods and services that are considered beneficial
* **encourage growth** of certain industries
* encourage exports
* improve **allocation of resources**
77
amount of subsidy
= vertical difference between both supply curves x quantity
78
effects of subsidies
* shifts the supply curve to the right
* reduces price for consumers
* increase of output (market failure is perceived as a lack of output)
* distorts price signals in the long term
* who a subsidy benefits depends on the subsidy and how it is used
* welfare effect = cost of the subsidy to the taxpayer – value of the benefits received
79
effect on different stakeholders of subsidies
* consumers ⇒ lower price for a greater quantity of goods
* producers ⇒ sell a greater quantity and receive a higher final price
* government ⇒ cost of the subsidy (opportunity cost)
* workers ⇒ bigger output → more workers needed → higher employment
80
price controls
appear as max prices, min prices, buffer stock, commodity agreement
81
price ceilings
* the government sets a maximum price **below equilibrium price**
* applied to necessity and/or merit goods
82
aims of price ceilings
* to **protect consumers** ⇒ reduce the price of certain goods for low-income consumers, prevent exploitation by monopolies
* **increase consumption** of a good or service
* ensure the **availability of necessities** for low-income households
83
consequences of price ceilings
* shortages
* rationing problems as not all interested consumers are able to purchase the good
* creation of black markets
* elimination of allocative efficiency, welfare loss due to the under-allocation of resources to the production of the good
84
black market
= market created by unintended consequences of government intervention, the selling of goods illegally at a price above max price
85
consequences for market stakeholders of price ceilings
* **consumers** ⇒ some (able to purchase at a lower price) are better off, some (unable to purchase at any price) are worse off
* **producers** ⇒ sell less for less → smaller TR
* **workers** ⇒ smaller market, fewer units of goods produced → some will be fired → unemployment increases
* **government** ⇒ no revenue cost or revenue, may gain political popularity or dissatisfaction
86
how to minimise consequences of price ceilings
increasing supply of the good until equilibrium is achieved at the max price by:
1. granting subsidies to producers
2. increasing production of the shortfall quantity of the good to meet total demand
3. store some of the product before setting of the price ceiling and increase supply when needed
87
price floors
government sets a minimum price above equilibrium price
88
aims of price floors
* to protect producers (usually in the case of commodities and the labour market)
* increase income producers of goods and services that the government considers important (agricultural products)
* protect workers by setting minimum wages
89
consequences of price floors
* surpluses
* promotes creation of black markets since they are unable to sell all of their goods
* firm inefficiency
* eliminates allocative efficiency, welfare loss
90
how to get rid of surpluses caused by price floors
government may purchase excess supply ⇒ shifting demand outward, and then: store it, export, send as aid to developing countries, burn it
91
how may price floors promote firm inefficiency
firms know they will receive a higher price no matter their inefficiency ⇒ unmotivated to reduce costs and use more efficient methods of production
92
consequences of price floors on **market stakeholders**
consumers ⇒ worse off due to consuming a smaller amount of the good at a higher price
workers ⇒ size of market increases → more workers are hired → employment rises
government ⇒ government buys surplus, incurring a cost ⇒ less funds to spend on other public goods and services (opportunity cost)
producers ⇒
1. government purchases the surplus ⇒ sell more than previously and at a higher price ⇒ TR increases
2. government doesn’t purchase the surplus ⇒ less products at a higher price ⇒ depending on PED, TR rises or falls
93
common pool resources
non-excludable, rivalrous natural resources, f.i. fishing grounds, the atmosphere
94
non-excludable ⇒
very difficult/impossible to exclude people from using the resources
95
rivalrous ⇒
every time the resource is used, the value of the resource decreases
absence of effective management ⇒ degradation of these resources
96
tragedy of the commons
a situation in which individuals with access to a common pool resource act in their own interest and, in doing so, ultimately deplete the resource
97
managing common pool resources:
1. “collective self-governance”
1. the government takes over the management of the resource, setting strict regulations for its use
1. land is privatized, its management being determined by the private owner
98
“collective self-governance”
* method of managing common pool resources
* individuals and communities can work together with regulation to develop rules and institutions in order to manage their shared resources in a sustainable and equitable manner
* communities who use the resource have the greatest incentive to maintain it ⇒ they should be the ones developing the rules for its management
* they are also more likely to implement, monitor and enforce those rules
99
progressive vs proportional vs regressive tax
* **Progressive** tax ⇒ a tax that takes a larger percentage of income from high-income groups than from low-income groups
* **Proportional** tax ⇒ a tax that takes the same percentage of income from all income groups
* **Regressive** tax ⇒ a tax that takes a larger percentage of income from low-income groups than from high-income groups (f.i. VAT)
100
free vs public vs private goods
* **Free** good ⇒ good with **no opportunity cost**, no scarcity (natural, f.i. air, sunlight)
* **Public** good ⇒ non-rivalrous, non-excludable goods, not provided in a free market, **manmade**, funded and provided by the government, non-rejectable
* **Private** good ⇒ **rivalry and excludability**, provided in a free market
101
market failure
= a state of the market in which **resources are not allocated optimally**, and **community surplus is therefore not optimized**, i.e. the market is unable to achieve allocative efficiency
102
externality
= the effect the production or consumption of a good or service on third parties
103
negative externalities
| def, on a diagram
* the externalities are harmful ⇒ there exists an external cost that must be added to the private cost to reflect the full cost to society
* Q (equilibrium; MPC = MPB) > Q (optimal; MSC = MSB)
104
positive externalities
| def, on a diagram
* the externalities are beneficial ⇒ there exists an external benefit which must be added to the private benefits of the consumer or producer
* Q (equilibrium; MPC = MPB) < Q (optimal; MSC = MSB)
105
no externalities ⇒
* social efficiency
* MSB = MPB = D/MSC = MPC = S
* no side effects on third parties
106
MSC, MPC
* MSC = the additional cost to the society from producing an extra unit of good (social supply curve)
* MPC= the additional cost to the producers from producing an extra unit of good => S = MPC
107
MSB, MPB
* MSB = the additional benefit to the society from consuming an extra unit of good
* MPB = the additional benefit to the consumers from consuming an extra unit of good => D = MPB
108
externalities of production on a graph
S curve (costs) splits into two
109
externalities of consumption on a graph
D curve (benefits) splits into two
110
positive externalities of consumption
| def, on a diagram, why its a market failure
* = goods or services with beneficial externalities to consumers and to third parties
* D curve splits into two, MSB > MPB (MSB = MPB + positive externality)
* too little of the product is consumed, there is an underallocation of resources to this market ⇒ form of market failure ⇒ potential welfare gain becomes a welfare loss, since society is losing welfare that would be achieved if the market was operating at the socially optimal level
111
merit goods =
goods that are **beneficial to consumers** and might not be consumed enough (due to the potential benefits being underestimated if consumers have imperfect information) ⇒ **demand is lower than it should be** from society’s perspective
112
increasing consumption of merit goods, goods with positive externalities
* subsidies
* improving information on the benefits of the merit good
* legislation
113
subsidies in increasing the consumption of goods that bring positive externalities
* shift of MSC down
* MSC is brought down so low that MPB = MPC + subsidy (or close to it) ⇒ price is lower, which increases demand
114
improving information on the benefits of the merit good in increasing the consumption of goods that bring positive externalities
* shifts MPB to the right (closer to MSB) ⇒ increasing welfare gain (decreasing loss)
* pros: most efficient in the long run
* cons: takes a while to take effect, minimal effect in the short run, high cost
115
legislation in increasing the consumption of goods that bring positive externalities
* only successful if offered to the public at a minimal price or at no price at all
* the population often grows to resent such legislation, being seen as an infringement on their civil liberties
116
positive externalities of production
| def, on a diagram
* production of a good or service creates beneficial consequences on third parties
* MSC < MPC
117
increasing the production of goods with positive externalities of production
* subsidies
* direct provision
118
subsidies as a means of increasing the production of goods with positive externalities of production
* MPC would be shifted down
* full subsidy is given ⇒ MPC = MSC
* difficult to estimate the level of subsidy deserved by each individual firm
* cost of subsidy ⇒ opportunity cost
119
direct provision as a means of increasing the production of goods with positive externalities of production
* high cost
* any improvement in the quality of labour, a factor of production, can shift out an economy’s PPC
120
negative externalities of consumption
* = the harmful effects of the consumption of a good or service on third parties
* a concequence of the overconsumption of demerit goods, i.e. the good is overconsumed/overproduced
* MSB < MPB
* can never be eliminated due to addiction
121
demerit goods
= goods that are harmful to consumers, but people who consume them are either unaware of the possible harm, or they ignore the possible risks and as so overconsumed
122
reducing negative externalities of consumption
* market-based approach: **indirect** taxes
* command and control approach: **legislation**, regulation
* **education**, raising awareness
* consumer **nudges**
123
indirect taxes as a means of reducing the external costs of production
* Pigouvian tax
* tax ⇒ MSC goes up
* government will gain significant revenue ⇒ can be used to correct some of the negative externalities caused by the good or service
* complicated process of deciding which goods should be taxed and the amount that should be taxed
* taxes are raised too high ⇒ consumers may look to buy the products in other jurisdictions, where the tax is lower ⇒ government does not gain significant revenue, quantity demanded is not lowered
* indirect taxes are deemed regressive: their impact is greater on lower income people, than higher income (as the tax takes up a larger proportion of the income of lower income people) ⇒ inequitable
* inelastic demand on such goods ⇒ tax does not bring down the demand on such goods significantly ⇒ revenue is raised, quantity demand is not lowered to socially optimal level
124
Pigouvian tax
indirect tax imposed on any market that creates negative externalities, in order to remove the externality
125
legislation as a means of reducing the external costs of consumption
* ⇒ inability to indulge in demerit goods ⇒ reduction in demand
* may be considered a way of taking away the rights of consumers to choose for themselves
* regulations are effective in changing consumer behaviour ⇒ negative effect on the producers ⇒ producers lobby the government to prevent them from bringing in new legislation
* legislation is difficult to enforce ⇒ the government must allocate sources to ensure that stakeholders comply with regulations and have mechanisms in place to punish those who do not comply
* a complete ban in most cases would not be eliminate consumption completely, as smuggling would arise
126
education as a means of reducing the external costs of production
* increasing information on the negative effects of a good/service, assuming its consumption is a consequence of imperfect information
* longer-term solution, doesn’t take effect immediately (unlike tax and legislation)
* funding of public awareness campaigns in order to reduce demand
* MPB shifts to the left
* the funding of these campaigns would ideally come from the taxes placed on the selling of this product
127
consumer nudges as a means of reducing the external costs of consumption
* consumers do not have perfect information, do not always make rational choices
* consumers still have their freedom of choice, but are nudged to choose differently ⇒ producers argue that their freedom to pursue profits is limited
* encourage consumers to reduce their consumption voluntarily
128
negative externalities of production
| def, on a diagram
* production of a good or service creates external costs that are damaging to third parties
* MSC > MPC
129
reduction of the negative externalities of production and the degradation of common pool resources
| methods of the reduction of the degradation of common pool resources
* international agreements
* market-based approach: tradable permits
* market-based approach: carbon taxes
* command and control: legislation, regulation
* subsidies
130
international agreements def
= an intergovernmental document intended as legally binding with a primary stated purpose of preventing or managing human impacts on natural resources
131
international agreements examples
* UNFCCC, IPC
* Kyoto Protocol, the Paris Agreement, Rio de Janeiro agreement
132
UNFCCC
| abbreviation, job, in cooperation with
* = the United Nations Framework Convention on Climate Change
* provides the framework for international negotiations and agreements
* works with the IPCC (Intergovernmental Panel on Climate Change), which provides policymakers with regular assessments of the scientific basis of climate change, its impacts and future risks, options for mitigation and adaptation
133
Pigouvian vs excise tax
* Pigouvian taxes are typically imposed to correct market failures
* excise taxes are typically imposed to generate government revenue rather than correct market failures
134
Kyoto Protocol
* first main agreement made under the **UNFCCC**
* objective: to cut **global emissions of greenhouse gases** by 5% between 2008 and 2012 relative to 1990 levels
* came into force in February **2005**
* mainly targeted the **advanced industrialized countries**, developing countries being asked to comply voluntarily
* became the foundation for the next international agreement (the Paris Agreement)
135
the Paris Agreement aims
* combating climate change, accelerate and intensify the actions and investments needed for a sustainable low-carbon future
* recognition of the interrelationship between human rights and climate change
* strengthen the global response to climate change to keep a global rise of temperature below 1.5 °C above pre-industrial efforts
* increase the ability of countries to deal with the impacts of climate change
* reducing emissions and reducing the concentration of CO2 by increasing “carbon sinks” = mitigation
136
the Paris Agreement mechanism
* each country sets its own NDCs (Nationally Determined Contributions) which establish its mitigation plans and goals
* NDCs must be updated every 5 years, each target showing a higher level of commitment to mitigation
137
the Kyoto Protocol vs the Paris Agreement
the Kyoto Protocol that set binding targets, while the Paris Agreement allows for each country to set their own targets with NDCs
138
tradeable permits as a means of reducing the negative externalities of production
| how they work, example
* market-based approach
* a governing body sets a limit on the ability of users to access to a (common pool) resource, then dividing up this limit into individual amounts
* individual states, countries, regions have set up their own emissions trading systems within their own economies
* ETS
139
ETS
| who, abbreviation, how it works
* **Kyoto Protocol** set up the **Emissions Trading Scheme**
* each member accepted a target for limiting or reducing emissions (the country’s allowed emissions, assigned amounts), which was then divided into **Assigned Amounts Units** (AAUs; **carbon credits**)
* country does not use up all their units ⇒ they are allowed to **sell these excess units** to countries that are over their targets ⇒ creating a **market for emissions**, which gives an **incentive** to adopt cleaner technologies, so that they are not required to buy carbon credits
140
effectiveness of ETS depends on:
* the **inclusivity** of the scheme (number of committed participants)
* whether the original allowances are **sufficient** to bring about the desired change
* the **manner** of allowance allocation
* the possibility of companies simply **absorbing the extra costs** of emitting and not changing their behaviour
* the ability of **accurate monitoring** of emissions
* the **severity of punishments** for excess emissions
* the possibility of the system being **manipulated** by stakeholders
141
carbon taxes as a means of reducing the negative externalities of production
* carbon tax = a tax imposed on the burning of fossil fuels
* a way of the external costs (negative externalities), that are not included in the market price, of carbon emissions being **internalised** by its consumers ⇒ follows the “polluter pays” principle (those who create pollution must be forced to pay for it)
* form of **Pigouvian tax** aimed at eliminating the negative externalities associated with emitting CO2, forcing the producer to pay the full costs of producing the product
* realistically **may not eliminate the welfare loss**, but moves closer to the socially optimal level of output
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benefits of carbon taxes
* firms invest in **newer and cleaner technologies** that allow them to emit less carbon in order to maintain profitability
* at higher prices, consumers will have an **incentive to reduce their consumption** of such products and may seek different sources of energy from renewable sources
* generates **government revenue**, which can be used to **subsidize** renewable energy sources to make them more affordable, **compensate** people by reducing taxes in other areas (carbon taxes are made “neutral”)
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legislation/regulation as a means of reducing the negative externalities of production
* strictly mandate the way producers behave
* to meet standards firms must spend money ⇒ increasing private costs ⇒ laws incentivize producers to make different choices about the way they produce their goods or services
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the concerns of legislation/regulation as a means of reducing the negative externalities of production
* do not allow for the **internalization** of the negative externality since there is no market-based incentive to get firms to reduce externalities
* the establishment of environmental regulations requires access to so much **information** (what is harmful, in what quantities, …)
* such regulations require the extensive careful consideration of various circumstances regarding different industries and ecosystems ⇒ **over-regulation** in some areas, under-regulation in others
* increased regulation ⇒ higher prices of goods and services, firms become **less competitive** against foreign producers
* regulations and standards have to be **strictly monitored** to ensure all stakeholders remain compliant (time-consuming and expensive)
* excessive environmental regulations concerning new technologies **discourage development** of technologies that could possibly achieve environmental benefits
* **governments are slow-moving**, resistant to change ⇒ cannot adapt when circumstances change
* must be **free from political interference**, as governments are subject to intense lobbying by stakeholders ⇒ may favour some areas of the environment over others as a result of stakeholders’ power and/or the desire to win votes
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regulatory capture
government agencies that are responsible for regulating a particular industry are heavily influenced by representatives of the industry they are supposed to be regulating
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subsidies as a means of reducing the negative externalities of consumption
reduction of costs on alternatives to goods and services that have negative externalities ⇒ people opt for such alternatives instead of the good/service that has negative externalities
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lack of public goods as market failure
technological advancements ⇒ more previously “public” goods are becoming private, forcing people to pay for them ⇒ people don’t have access to these goods ⇒ market failure
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how can market failure, which is a consequence of a lack of public goods, be corrected?
* direct provision
* public-private partnership
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direct provision as a means of reducing market failure, which is a result of a lack of public goods
* usually the case with national defence, flood barriers, roads, pavements, street lighting, …
* funded with taxpayer money ⇒ spreads the cost over a large number of people who would not be prepared to pay individually
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public-private partnership as a means of reducing market failure, which is a result of a lack of public goods
* the government works in partnership with the private sector and funding the establishment of the good and allowing the private producer to run it
* controversial since it is assumed that private institutions will only engage in affairs that earn them profit
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public vs merit good
* **Public** good ⇒ **non-rivalrous**, **non-excludable** goods, **manmade**, **not provided** in a free market, funded and provided by the government, collective consumption, **unconstrained in supply**, **non-rejectable**
* **Merit** good ⇒ commodities provided by the **public/private sector** for a **small or nonexistent fee**, the government feels that these services could be **under consumed** due to imperfect information, people must have **regardless of their ability to pay**, **rivalry and excludability**, provided by both the **public and private sector**, **rejectable** by those unwilling to pay for the good or service
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quasi-public good
| def, example
have some, but not all of the characteristics of public goods
f.i. roads
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asymmetric information
| def, types
one party in an economic transaction has access to more/better information than the other party
types: adverse selection, moral hazard
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adverse selection
* ⇒ one party in an economic transaction has better information than the other
* poor choices are made from society’s point of view
* cause **missing markets**, since consumers have imperfect knowledge ⇒ they may avoid transactions, preventing a market from forming ⇒ markets fail to provide them ⇒ market failure since **resources are not allocated efficiently**
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ways of getting past adverse selection
* screening ⇒ the less informed party can find a way to get the other party to reveal relevant information
* signalling ⇒ the party with more information provides reliable information to the party with less information
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moral hazard
* ⇒ people have an incentive to alter their behaviour and take more risks when they know that the negative consequences will be borne by others
* any situation in which one person makes the decision on how much risk to take while someone else bears the cost if things go wrong
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how to get around moral hazards
deductibles = the amount of money that the insured person must pay before their insurance policy starts paying for covered expenses ⇒ act as disincentives to risky behaviour
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adverse selection vs moral hazard
1. **adverse selection** ⇒ market failure occurs **before** an economic transaction has been made (the party with **more information** has an advantage going into the transaction
1. **moral hazard** ⇒ market failure occurs **after** an economic transaction has been made (party **taking the risk** has the advantage following the transaction)
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short-run vs long-run production
short-run ⇒ quantities of one or more production factors cannot be changed (fixed inputs)
long-run ⇒ all production inputs are variable
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economic profit
TR - costs (implicit, explicit, opportunity costs)
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accounting profit
TR - explicit costs
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normal vs abnormal profit
Normal profit ⇒ economic profit = 0 (just covering all costs)
Abnormal profit ⇒ economic profit > 0 (costs are being covered
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two types of opportunity costs (depending on who owns the resources the firm uses)
1. **implicit**: resources are owned by the firm ⇒ no monetary payments made ⇒ opportunity cost = sacrifice of income that would have been earned if the resource had been employed in its best alternative use
2. **explicit**: resources are owned by outsiders from whom the firm acquires them ⇒ monetary payment to the supplier in exchange for the resource = accounting costs ⇒ opportunity cost = amount paid to acquire resources
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economic costs
explicit + implicit costs = total opportunity cost incurred by a firm for its use of resources, whether purchased or self-earned
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production function
the highest output that a firm can produce for every specified combination of inputs given the state of technology (what is feasible under efficiency)
production function for two inputs: Q = f(K, L)
| K (capital), L (labor)
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fixed costs
| def, arise when, exist, examples
* = costs that do not change as output changes
* arise from the use of fixed inputs
* arise only in the short run when the firm has fixed inputs
* exist even if output is 0
* f.i. rent, loan interest, tax, …
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variable cost
| def, arise when, general rule
* = costs that vary as output changes
* arise from the use of variable inputs
* generally: more variable input ⇒ greater variable costs
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total costs
= fixed costs + variable costs
the long run (fixed costs = 0) ⇒ total costs = variable costs
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average costs
= costs per unit of output (how much each unit of output produced by the firm costs on average)
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average fixed/variable/total costs
AFC … average fixed costs ⇒ AFC = TFC/Q
AVC … average variable costs ⇒ AVC = TVC/Q
ATC … average total costs ⇒ ATC = TC/Q = AFC + AVC
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marginal cost
= the extra or additional cost of producing one more unit of output
how much total costs increase if there is an increase in output by one unit
MC = ∆TC/∆Q = ∆TV/∆CQ
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total revenue
TR = PxQ
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marginal revenue
marginal revenue = the additional revenue from the sale of an additional unit of output
MR = ∆TR/∆Q
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average revenue
= revenue per unit of output
AR = TR/Q
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marginal product
the additional product produced by one additional unit of variable input
MP = ∆TP/∆units of variable input
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average product
= product per unit of variable input
AP = TP/units of variable input
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a firm’s costs depend on
1. the level of output it produces
2. input prices (determined in product markets through supply and demand)
3. the quantities of inputs required to produce, which depend on a technical relationship between the inputs and the output that these produce
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where does MC intersect AC and AVC?
at their lowest points
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lowest point of MC ⇒
diminishing marginal returns set in
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scales of production
1. **constant returns to scale** ⇒ constant LRATC over a certain range of output (does not encounter (dis)economies of scale), returns match investment
1. **increasing** returns to scale (returns are greater than investment, usually a result of economies of scale)
1. **decreasing** returns to scale (returns are smaller than investments)
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typical long-run average cost curve
many firms exhibit constant returns to scale after exhausting economies of scale and do not run into diseconomies of scale
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minimum efficient scale
= lowest long-run total average costs achieved
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LRAC curve
a curve showing the lowest possible average cost that can be obtained for any level of output when all of the outputs are available
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total revenue
sum of all sales of a firm (TR = PQ)
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marginal revenue
change in TR from the sale of one more/less unit
MR = ∆TR/∆Q
186
when is TR at its maximum?
MR = 0
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average revenue
revenue per unit sold
AR = TR/Q = P
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PED at, after and before TR maximum
at maximum ⇒ PED = 1
after maximum ⇒ inelastic demand
before maximum ⇒ elastic demand
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AR curve in perfect and imperfect competition
perfect competition ⇒ price prevails, no tendency to change in the short-run ⇒ P = AR = MR
imperfect competition ⇒ the firm is a price maker ⇒ AR curve is downward sloping, so is MR
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objectives of firms
1. profit maximization
1. growth maximization ⇒ to gain large market share for domination in the long-run, economies of scale
1. revenue maximization
1. corporate social responsibility
2. satisficing ⇒ an economic agent aims to perform at a satisfactory level, not the maximum level due to involvement in many areas
3. managerial utility maximization (aka of the utility/satisfaction of managers themselves)
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types of profit maximization
1. based on TR and TC ⇒ TR - TC is maximized
1. based on MR and MC ⇒ MC = MR
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purpose of company social responsibility
* integrate social and environmental concerns into their business operations and in their interaction with their stakeholders on a voluntary basis
* preservation of a good reputation for the future of the firm
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characteristics of perfect competition
* firms cannot set the price ⇒ “price-takers”
* very large number of firms ⇒ each firm’s output is very small in relation to the size of the market
* the actions of one firm affect the actions of another
* no barriers to enter or leave the market
* homogeneous products
* all economic agents have perfect knowledge
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what does it mean for agents to have perfect knowledge in perfect competition?
* no **producer** has access to information that would allow it to produce at a lower cost than others
* **consumers** are aware of the market-determined price, and are therefore unwilling to pay more for the product
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short-run in perfect competition
* firms take the price from the industry ⇒ demand is perfectly elastic
* produce at the profit-maximizing level (MC = MR)
* the firm’s supply curve is the MC curve above AVC
* ATC > P ⇒ loss; >AVC ⇒ firm is creating losses, but cover their variable costs ⇒ continue selling since fixed costs exist even without production
* P = minimum AVC ⇒ firm’s total loss = firm’s fixed costs ⇒ do not cover variable costs ⇒ can no longer produce
* ATC < P ⇒ profit
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long-run in perfect competition
abnormal profits are unachievable in the long run ⇒ in the long-run all firms make normal profit (adjusts its price with firms entering/leaving the industry until normal profits are achieved)
productive, allocative efficiency and profit-maximizing levels of outputs coincide => no market failure
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profits in the short run for perfect competition ⇒
new firms enter the market ⇒ greater supply ⇒ equilibrium price shifts down ⇒ profits return to normal profits
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losses in the short run for perfect competition ⇒
⇒ firms leave the industry ⇒ supply increases ⇒ equilibrium price shifts upwards ⇒ profits return to normal profits
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advantages of perfect competition
* **low costs**, no long-run supernormal profits ⇒ low prices for consumers
* **incentive for firms to be efficient** in order to earn supernormal profits in the short run and not be driven out of business ⇒ development of technology
* products are homogeneous ⇒ no point in advertising ⇒ smaller costs and more economical use of scarce resources ⇒ lower ATC curves
* firms produce at the **least-cost output in the long-run**
* increased demand, consumers call for extra supply ⇒ short-run increase in profit ⇒ **optimal allocation of resources**
* firms have **no power** to manipulate the market, they can only change profits by becoming more efficient
* allocative and productive efficiency are achieved in the long-run ⇒ **no market failure**
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monopoly characteristics
* industry with a **single seller** (product is unique)
* demand curve of the monopoly firm = demand curve of the industry
* demand curve is downward sloping
* monopoly firm has control over the price (“**price maker**”) by varying total supply of the product
* power of a monopoly depends on the availability and closeness of substitutes (monopoly has **no close substitutes**)
* **barriers** to entry and exit to the market (legal, natural)
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market power def
company's relative ability to manipulate the price of an item in the marketplace by manipulating the level of supply
202
barriers to entry def
constraints to protect a firm from potential competition (legal or natural)
203
economies of scale def
the cost advantages that a firm experiences as it increases its level of production ⇒ as a firm grows, it can spread its costs over more units, making each unit cheaper to produce
204
causes of economies of scale
* more efficient use of resources
* better deals are available (bulk buying)
* better technology and labour (specialization)
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diseconomies of scale
increases in the average costs of production that occur as a firm increases its output by increasing all inputs
206
economies of scale in monopoly power
monopolies are very large ⇒ strong economies of scale ⇒ huge cost advantage over any smaller competitors ⇒ lower prices than new entrants and still make a profit, keeps competition out, investing more in advertising, technology, or lobbying, making it even stronger
⇒ barriers to entry, source of monopoly power
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natural vs legal monopoly
**Natural** monopoly ⇒ only enough economies of scale available in the market to support one firm (monopolization is the most efficient) ⇒ natural barriers to enter (f.i. gas, water, …)
**Legal** monopoly ⇒ competition and entry are restricted by granting: public franchising, government licenses, permits, patent, copyright, trademark
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market failure in monopoly?
allocative and productive efficiency are not achieved ⇒ market failure
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price wars
⇒ another firm enters the industry the monopoly can lower its price to loss-making level (new firm cannot sustain, monopoly can)
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advantages of perfect competition:
* low prices
* encouragement of development for efficiency
211
disadvantages of perfect competition
* no choice
* impossible to gain long-run profit
* difficult to plan/predict for as things change fast
212
advantages of monopoly
* supernormal profits can be used for research, development and investment ⇒ greater ability to become more efficient than small firms with limited funds
* can achieve large economies of scale ⇒ MC are lower ⇒ higher output with a lower price than in perfect competition
* most efficient use of resources in most cases
* use profit to invest, research, development
* more ability to become efficient relative to small firms
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disadvantages of monopoly
* consumers have no choice
* the firm has all market power
* significant economies of scale do not exist ⇒ monopoly restricts output and sets a higher price, since monopolies will produce at MC = MR, while the perfectly competitive market will produce at MC = D (industry supply = industry demand)
* allocative and productive efficiency are not achieved
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characteristics of monopolistic competition
* large number of small firms
* slightly differentiated products ⇒ firms compete on price, quality, marketing
* no barriers to entry and exit ⇒ firms cannot earn economic profit in the long-run since it attracts new firms
* each firm has its own downward-sloping demand curve for its product
215
profits in the short and long run in monopolistic competition
abnormal profits are possible in the short run, not in the long-run (entry to the market continues as long as the industry earns an economic profit)
216
consequences of there being a large number of small firms in monopolistic competition
* firms only have a small market share ⇒ limited market power to influence the price of its product
* firms are sensitive to the average market price
* no firm pays attention to actions of another, the actions of one firm does not affect another
* impossible for collusion to occur
217
market failure in monopolistic competition
productive and allocative efficiency are not achieved in the long-run ⇒ market failure
218
differences of monopolistic competition from perfect competition
* higher costs (marketing, branding, and nonprice competition)
* can set their own prices ⇒ higher prices
* product differentiation ⇒ customer loyalty, power to set their own prices
* firms rely on non-price competition to increase demand (shift the curve to the right)
219
characteristics of oligopoly
* few producers with high market power
* homogeneous products
* barriers to entry and exit
* perfect information
* perfect mobility of inputs
* highly unpredictable, as when collusion is banned there is no way to know what other firms may do and oligopoly is highly interdependent
* firms compete through price and non-price factors
220
market failure in oligopoly
allocative and productive inefficiency in the long-run ⇒ market failure
221
nature of competition in oligopoly
price ⇒ risky (price wars do not benefit any consumer)
non-price ⇒ branding, build customer loyalty to gain market share
222
collusive vs non-collusive oligopoly
1. **collusive** ⇒ an agreement (mostly verbal) between two (or more) firms to **restrict output, raise price, and increase profits**, illegal, undertaken in secret, operate a **cartel**, act as a **monopoly**, maximise collective profit ⇒ **incentive to cheat** and partake in illegal activity
2. **non-collusive** ⇒ firms have to be aware of the **reactions of other firms** when making pricing decisions, one firm changes its output ⇒ market price changes along with the profits of competitors ⇒ they react by changing their own outputs
223
means of abusing high market power
* restriction of output ⇒ higher prices, distortion of resource allocation
* low consumer choice
* allocative and productive inefficiency
* abnormal profits, inequity
224
government intervention to restrict market power in monopoly and oligopoly
prohibition ⇒ monopoly formation is banned, existing ones are broken down into competing units
takeover ⇒ government nationalizes the monopoly, runs it in public interest
regulation ⇒ government allows for monopolies to continue but pass legislation to ensure it acts in public interest
225
consumer, producer, community surplus
consumer => the sum of the net gains to each individual buyer from the purchase of a good in a market (sum of individual consumer surpluses)
producer => the sum of the net gains to each seller from selling a good in a market (sum of individual producer surpluses)
community = consumer + producer
226
when is community surplus maximized
when the market is in equilibrium ⇒ any change to it causes surplus decrease
no other combination than the equilibrium gives greater community surplus
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deadweight (welfare) loss
reduction in net economic benefit due to inefficient allocation of resources
