midterm 1 Flashcards
opportunity costs
the true cost of something is the next best alternative you have to give up to get it
consequence of choice in relation to next best alternative
scarcity
resources are limited and any resource spent on pursuing one activity leaves fewer resources for another
economic surplus
total benefits-total cost
assesses how much a decision has improved well being
cost benefit principle
costs and benefits are the incentives that shape decisions.
before making a decision you should evaluate all costs and benefits and pursue only if benefits are greater than costs
willingness to pay
quantifies costs and benefits, “what is the most I am willing to pay for this”
sunk cost
cost that has been incurred and cannot be reversed
good decisions ignore sunk costs. they occur with every choice
ppf
illustrates alternative outputs
marginal principle
decisions about quantities are best made incrementally.
rational rule
if something is worth doing keep doing it until marginal benefits equal marginal cost. maximizes economic surplus
interdependence principle
best choice depends on other choices, choices others make, developments in other markets, and future expectations. when these change the best choice may change
4 types of interdependence
dependencies between individual choices
dependencies between people/business in the same market
between markets
through time
gains from trade
extra output from rearranging according to comparative advantage
absolute advantage
ability to do a task using fewer inputs
who should do a task
person with lowest opportunity cost
comparative advantage
ability to do a task at lower opportunity cost
how to determine who has comparative advantage
determine how long the task would take each person
convert to opportunity cost (calculate how much of an alternative good you could produce
evaluate who can produce each good at lowest OC
specialization
focusing on task that you have lowest opportunity cost in
internal market
markets within a company to buy/sell scarce resources
knowledge problem
knowledge needed to make a good decision is not available to decision maker
individual demand curve
plots the quantity of an item that someone plans to buy at each price
quantity demanded is higher when
price is lower
market demand curve
total quantity of a good demanded by the market across all potential buyers at each price
market demand
sum of quantity demanded by each person
4 steps to finding market demand curve
1) survey customers asking the quantity they will buy at each price
2) for each price, add up total quantity demanded by each individual at that price
3) scale up that quantities demanded by survey respondents so that they represent the whole market
4) plot total quantity of goods demanded by market at each price
a change in price only causes
movement along the demand curve
the demand curve is also which curve
marginal benefit curve
right shift =
increase in demand
left shift =
decrease in demand
6 factors that shift the demand curve
1) income
2) preferences
3) prices of related goods
4) expectations
5) congestion, network events
6) the type and number of buyers
normal good
demand increases when income is higher
inferior good
demand decreases when income is higher
complementary goods
goods that go together
when the price of a complementary good rises, demand
decreases
substitute goods
goods that replace each other
what does demand for a good do if price of a substitute good rises
increases
network effect
when a good becomes more useful other people use it
congestion effect
good becomes less valuable because other people use it
individual supply curve
plots quantity of item business plans to sell at each price
law of supply
tendency for quantity supplied to be higher when price is higher
perfect competition
markets in which all firms in an industry sell an identical good
and
there are many buyers and sellers, each of whom is small relative to size of market
price taker
someone who charges prevailing price and whose actions do not affect prevailing price
variable cost
vary with amount of output produced
fixed costs
do not vary when output changes
rational rule for sellers
keep selling until price equals marginal cost
marginal product
increase in output that arises from additional unit of input
diminishing marginal product
marginal product declines as you use more of that input
raised input = raised marginal
cost
market supply curve
plots total quantity of an item supplied by entire market at each price. sum of quantity supplied by each seller
rise in price = what in quantity supplied
increase
supply curve is also
marginal cost curve
5 factors that cause supply curve to shift
1) input prices
2) productivity and tech
3) prices of related outputs
4) expectations
5) type and number of sellers
4 and 5 only shift market supply curve
substitutes in production
alternative use of resources
what does supply of good do if price of substitute in production rises
decreases
complements in production
produced together
what will supply do if price of substitutes in production falls OR price of complements in production rise
increase
always use what when graphing ppf
x and y intercept
numerator of OC
task that is neglected
planned economy
centralized decisions are made about what and how goods and services are produced and allocated
market economy
each individual makes their own production and consumption needs, buying and selling in markets
market
a setting that brings together potential buyers and sellers
equilibrium
point at which there is no tendency for change
a market is in equilibrium when quantity demanded = quantity supplied
equilibrium quantity
quantity demanded and supplied are at equilibrium
shortages cause price to
rise
shortage
quantity demanded exceeds quantity supplied
surplus causes price to
fall
surplus
quantity demanded is less than quantity supplied
price above equilibrium
causes a surplus
price below equilibrium
causes a shortage
3 symptoms of a market at a shortage
1) queuing
2) bundling extras
3) a secondary market
if there is a surplus the same things will occur in reverse
demand shifts cause price and quantity
to move in the same direction
shift in supply causes price and quantity to move in
opposite directions
price elasticity of demand
measures how responsive buyers are to price changes
p.e. of demand formula
percent change in quantity demanded/ percent change in price
use absolute value with final answer to determine elasticity, but remember this should always be negative numbers wise
elastic
absolute value of price elasticity is greater than 1
responsive
inelastic
absolute value of price elasticity is less than 1
buyers are unresponsive to price change
unit elastic
elasticity is exactly 1 or negative 1
elastic demand curves are …… than inelastic demand curves
flatter
perfectly elastic
change in price leads to infinite change in quantity
horizontal demand line
perfectly inelastic
quantity does not respond to a change in price
vertical demand line
if you have good substitutes demand is more
elastic
elasticity reflects the availability of a
substitute
price elasticity of demand reflects availability of substitutes and is larger when
1) there are more competing products
2) for specific brands
3) for things that are not nessecities
4) when consumers search more
5) when there is more time to adjust
total revenue
price*quantity
if demand is elastic a higher price produces
less revenue
if demand is inelastic a higher price produces
more revenue
if demand is currently inelastic for your product, you should
raise prices
cross price elasticity of demand
measures how responsive prices quantity demanded of one good is to price changes of another
cross price elasticity of demand formula
percent change in quantity demanded/ percent change in price of other good
cross price elasticity is positive for
subsitutes
cross price elasticity is negative for
complements
cross price elasticity is zero for
independent goods
income elasticity of demand
change in quantity demanded in response to a change in income
income elasticity of normal goods is
positive
income elasticity of inferior goods is
negative
price elasticity of supply
responsiveness of sellers to price changes
will always be positive
quantity is unresponsive when supply is
inelastic
quantity is responsive when supply is
elastic
price elasticity of supply is increased when
1) firms store inventory
2) inputs are easily available
3) firms have extra capacity
4) when firms can enter or exit
5) more time to adjust
if supply and demand both shift there can be more than one possible outcome which means that either price or quantity will be
ambiguous
positive analysis
descibes what will happen
normative analysis
describes what should happen
the most effeciant outcome is the outcome that yields
the most surplus
economic surplus
total benefits - total cost
measures how much a decision improves your well being
equity
a measure of fairness
a more fair distribution of economic resources
consumer surplus
marginal benefit - price
triange closer to the top of the graph
surplus from buying
effecient production
producing a given quantity of output at the lowest possible costs
effecient quantity
quantity that produces largest amount of economic surplus
rational rule for markets
produce more of an item if the marginal benefit of the item is greater than or equal to its marginal cost
market failure
forces of supply and demand lead to an ineffecient outcome
5 market failures
1) market undermines competitive pressure
2) externalities create side effects
3) information problems undermine trust
4) irrationality leads to bad decisions
5) government can impede market forces
deadweight loss
how far economic surplus falls below effecient outcome
DWL=
surplus at effecient quantity - actual economic surplus
deadweight loss is always pointed at the
effecient quantity
3 critiques on effeciency
1) distribution matters. we should account for equity
2) willingness to pay affects ability to pay, not just. MB
3) the means matter, not just the ends
MC of the last unit produced will be the same for
all firms because each firm will produce up to the point where MC= price
if less than the effecient quantity is consumed
mutually beneficial exchanges will not occur
if more than the effecient quantity is consumed
some goods will go unsold
what is the market failure in the used car market
private information
more narrow market =
more elastic demand
a demand line shows the exact
marginal benefit
a demand line shows
max you would pay for each unit of a good
what does a tax on sellers cause
1) a shift in the supply curve
2) decline in quantity sold
3) increases price buyers pay
4) decreases price sellers recieve
who bears the incidence of a tax on sellers
both buyers and sellers
what does a tax on buyers cause
1) shift in the demand curve
2) decline in the quantity sold
3) increases what buyers pay
4) decreases what sellers recieve
who bears the incidence of a tax on sellers
both buyers and sellers
statutory burden
it doesnt matter if tax is on the seller or buyer, the result is the same
tax incidence
depends on price elasticity of demand and supply
refers to the distribution of the economic burden of a tax between buyers and sellers. It analyzes who ultimately bears the cost of a tax, regardless of who is legally responsible for paying it to the government.
sellers bear a smaller share of the tax incidence when
supply is relatively elastic
buyers bear a smaller share of the tax incidence when
demand is relatively elastic
the factor (supply/demand) that is more elastic will have a ……. share of economic burden
smaller
how to evaluate a tax or subsidy
1) determine which curve is shifting
2) consider if it is an increase or decrease in taxes
3) compare pre and post tax equilibrium
4) see if supply or demand is more elastic in order to assess who bears greater burden of the tax
subsidy
payment made by government to theose who make a specific choice
price celing
max price to be legally charged
price floor
min price that sellers can legally charge
binding price celing
price celing that prevents market from reaching market equilibirum price
price celings lower prices but they cause
shortages
binding price floor
prevents the market from reaching equilibrium price
quantity regulation
max or min quantity that can be sold
quota
limit on max quantity of a good that can be bought or sold
mandate
requirement to buy or sell a min amount of a good
what do quotas do to prices
raise them
when a competitive market is at equilibrium total surplus is
as large as it can be
statutory burden
burden of being assigned by government to pay tax
economic burden
actual burden created by changes in price due to a tax
tax incidence
division of burden between buyers and sellers
negative externality
effects harm bystanders
externality
side effect of an activity that affects bystanders whose interests are not taken into account
positive externalities
side effects benefit bystanders
price change is not a
externality
negative externalities create
external costs
marginal price cost
cost paid by the seller from one extra unit
marginal external cost
cost imposed on bystanders
marginal social cost
sum of marginal private costs and marginal external costs
marginal external benefit
extra benefit enjoyed by bystanders
marginal social benefit
sum of marginal benefit accruing to buyer and marginal external benefit accrued to bystanders
social optimal quantity
quantity thats the most effecient for society as a whole
occurs where marginal social benefit =marginal social cost
negative externalities lead to
overproduction
positive externalities lead to
underproduction
coase theorum
if bargaining is priceless and property rights are enforced, externality problems can be solved by private bargains
corrective taxes can solve
negative externalities
set corrective tax on negative externaility equal to
the marginal external cost
corrective subsidy can solve
positive externaities
you can cap a negative externality using
quantity regulation
cap and trade is like a
corrective tax
lawsuits, norms, social sanctions are like a
corrective tax
warm glow, social recognition are like a
corrective subsidy
laws rules and regulations can solve
externalities
non excludable goods
people cannot be easily excluded from using it
non rival goods
one persons use does not subtract from anothers
free rider problem
someone can enjoy benefits of a good without paying the costs
with nonrival goods, free rides enjoy a
positive externality
rival goods
use of good comes at the expense of someone else
public good
non rival good that is non excludable and therefore subject to free rider problem
markets ……….produce public goods
under
club good
excludable but nonrival in consumption
common resource
rival and non excludable
tradgedy of the commons
tendency to overconsume common resources
how to solve tradgedy of the commons
assign ownership rights
what type of goods create externality problems
non excludable
6 solutions to externality problems
1) private bargaining
2) fix the price through a tax or subsidy
3) fix the quantity through cap and trade
4) laws, rules, regulations
5) government provisions of public goods
6) assign ownership rights to common resources
what are the 3 consquences of a tax
1) tax raises revenue for governments
2) taxes reduce producer and consumer surplus
3) taxes create deadweight loss
subsidies are opposite of taxes in the way that whichever is less elastic gets to keep
more of the surplus
consequences of a price floor
1) choosy buyers because there is more demand
2) suppliers will try to sell on a black market
3) suppliers keep producing excess, government keeps having to step in to buy the surplus
4 unintended consequences of price celings
1) excess demand means that supplies do not need to worry about losing customers, makes quality decrease
2)suppliers find other ways to profit
3) black markets may emerge
4) suppliers will pivot into differeny industries
binding quota
quota is below equilibrium quantity
DWL triangle is located inbetween
what society is doing and what it should be doing
if the market is functioning properly social optimum is
the equilibrium point
supply curve slopes up to reflect increasing ……. demand curve slopes down to reflect decreasing ……
MC….. MB
what shift happens: negative externaility
supply shifts left
what shift happens: positive externality
demand shifts right
when the price of a good takes up a higher share of income, it is more
elastic
the more vertical a slope is
the less elastic it is
new tech causes production to be cheaper which in turn lowers …… and therefore increases ……
MC, supply
more elastic (demand/supply) = ……. loss from tax
smaller
where are these located on the ppf: effecient, ineffecient, infeasible
effecient: on the ppf line
ineffecient: below the ppf line
infeasible: above ppf line
OC of y =
x/y x (units)
positive externalities shift the …… to the ……
demand curve (social), right
negative externalities shift the …… to the ……..
supply curve (social), left
how does a tax levied on sellers affect supply and demand curves
supply shifts left, demand remains unchanged
how does a tax levied on buyers affect supply and demand curves
demand shifts left, supply is unchanged
when given a supply and demand function, where do you put the tax (on buyers) when you integrate the equations?
ex) S(p) = 2p
D(p) = 100-p
tax is $10
you would add the tax to the demand function
ex) S(p)= 2p
D(p) = 100-(p+10)
therefore D(p) (tax) =90-p
when given a supply and demand function, where do you put the tax (on sellers) when you integrate the equations?
ex) S(p) = 2p
D(p) = 100-p
tax is $10
you would subtract the tax from the supply function
ex) S(p) = 2 (p-10)
D(p) = 100-p
therefore S(p) = 2p-20
how do you factor a positive externality into supply and demand functions?
ex) s(p) =2p
d(p) = 10-p
positive externality of $2
adjust the demand function by adding externality
ex) d(p) (social) = 12-p
how do you factor a negative externality into supply and demand functions?
ex) s=2p
d=10-p
adjust the supply curve by adding the cost
s (social) = 2 (p+2), therefore
s (social) = 2p+4
