Midterm 1 Flashcards
Complements
Things that go hand in hand (use together with)
Ex: Corn and butter go hand in hand.
Price goes UP then Quantity demanded goes DOWN. Vice versa (opposites).
Substitutes
Things that you use in place of something.
Ex: Margarine is a substitute for butter.
A decrease in the price of a
substitute shifts demand down and to the left.
Price goes UP then Quantity demanded goes UP.
(P and Q will always be in the same direction)
Inferior Goods
Inferior goods have a negative income elasticity.
Ex: People will buy better things when their income goes up. iPhone 1 demand will go down, because people have more money to buy better phones.
Income decrease -> Price goes UP and Quantity demanded goes UP
(vice versa)
Increase in supply/production
Increases in productivity means suppliers can produce more at lower costs.
Price goes DOWN, and Quantity demanded goes UP
The increase in price of smidgets.
The increase in labor productivity.
Combining the two, what would happen?
The INCREASE in price of smidgets causes both the quantity and price of widgets both
FALL. The increase in labor productivity would cause the price of widgets to go DOWN and
its quantity to go UP. Combining the two, prices will go DOWN, but the effect on quantity
would be ambiguous.
Normal Goods
Income increase means quantity demanded goes UP.
Ex: When your income goes UP the quantity demanded for iPhones goes UP.
Qfigget remains unchanged while Pfigget increases
Since there is no change in quantity, either supply or demand will be perfectly
inelastic or both. In this case, It cannot be both, however, since price increased. Income is one of the
shifters of demand curve so the demand curve must have shifted. Price will increase
when the demand curve shifts to the right which means quantity demanded goes up
when income increases. This fits into the definition of normal goods.
Pareto Efficiency
An allocation is possible/easy and no other way to make someone better off without making someone worse off. Total surplus is maximized (Pie is as big as it can be)
In a free market, there must be no externalities and perfect competition.
Rules of Pareto Efficient
General Principal #1: Efficient Allocation of Consumption
In any efficient allocation, consumers with highest willingness to pay get to consume.
General Principal #2 : Efficient Allocation of Production
Producers with the lowest cost produce
General Principal #3: Efficient Quantity Marginal reservation value of the last buyer should be equal to
marginal cost of last seller.
Perfectly inelastic supply
eS =0
Supply curve is vertical and doesn’t change
Perfectly elastic demand
eD = infinity
Line is horizontal
Perfectly inelastic demand
eD = 0
Examples: 700 students buying 1101 book in Spring 2018 at $112
Same number of students will still buy if price is $50 or $130
Theoretically ideal concept: if price raised to $1 million, students will drop out.
Demand curve is vertical; stays the same no matter what
Clearing the Market
To “clear the market,” the quantity supplied and quantity demanded must be the same.
Total tax revenue
The total tax revenue is the quantity
consumed (1) times the amount of the tax ($8). Thus, the total tax revenue is $8.
Subsidy of $2 (look at graph)
With a subsidy, the wedge is placed to the right of the free market equilibrium. Quantity times by the Supply price. This gives us (6*6)/2=18.
The equilibrium price of a unit of taxi quota
The quota is set such that the quantity is 2. Then we take the equilibrium price of a unit of tax,
is the price between Supply Price at Q=2 (2) and the Demand Price at Q=2 (8). Thus,
the answer is 8-2=6.
Inelastic demand
Price > Quantity
Quantity demanded will not change as much as price will.
Elastic Demand
Price < Quantity
Price will not change as much as quantity demanded will change.
Elasticity depending on short/long run
Elasticity in the long run is greater than in the short run.
Cap and trade
Cap and trade is a mechanism through which the amount of milk sold is reduced relative to the quantity of free market and the price is above the price of free market. A subsidy increases the quantity relative to the free market quantity. Consumers end up paying more in the cap and trade system.
Income elasticity
income elasticity:
(1) For inferior goods, income elasticity is negative.
(2) For necessity goods, income elasticity is between zero and one.
(3) When income elasticity for a good is greater than one, the share of income spent on the good
is higher with higher income.
Factors that determine Demand
- Price of a related good (complement or substitute)
- Income of consumers
- Tastes of consumers
- Number of consumers
- Expectations of consumers
Factors affecting supply
- Price of inputs
- Production technology
- Number of producers
- Expectations of producers
Supply shifts down and to the right
Increase in equilibrium Quantity and decrease in equilibrium Price.
Unit elastic
Unit elastic is a change in price that causes a proportional change in the quantity demanded.
Tax burden
The more inelastic part of the market bears the burden.
For consumers to bear the whole tax burden, demand should be perfectly inelastic.
If producers were to bear the whole tax burden, supply should be perfectly inelastic.
In any Pareto efficient allocation
Producer surplus does not have to equal consumer surplus.
In the unregulated market equilibrium, excess demand must be zero.
In the unregulated market, the equilibrium price is such that QD=QS , hence Excess Demand = QD – QS= 0.
Subsidy of $6. What is the equilibrium quantity with the subsidy?
PD = Tax + PS. In this case we have a subsidy of $6 hence Tax = -$6. This implies that the equilibrium quantity is where PD = -6+ PS. This happens when Q=8, because in this case PD = 2 and PS = 8.
Total government expenditure
Subsidy x quantity supplied by gov = Total gov expenditure
Change in total surplus ($6 subsidy)
In the graph, the deadweight loss corresponds to the area in which the supply curve is above the demand. The area of the triangle corresponding to the deadweight loss is (1/2)x(8 - 2)x(8 - 5) = 9. Since it is a loss, - 9.
Price ceiling of $2, Excess demand =
With price ceiling of $2, excess demand is Quantity demanded - Quantity supplied . ( 8 - 2 = 6 )
Perfectly inefficient rationing
Buyers with the lowest reservation value will acquire the
widget.
Start from right to left. (Quantity 8 with price ceiling of $2.)
So (1/2) * (8-6) * (4-2)
When price floor is below equilibrium
A price floor establishes the minimum price in the market. A price floor of $2 is below the equilibrium and it is not a binding constraint. That is, it does not affect market allocation. The consumer surplus is calculated as usual, CS = (1/2)x(5 - 0)X(10 - 5) = 12.5
The policy caps the total amount of quota at 4 units. The equilibrium price of one unit of quota at the quota exchange equals
The policy caps the total amount of quota at 4 units. So the owner of a quota face the following
decisions If produce, profit for selling the good are given by $2 = $6-$4 => Pd - Ps. If he sells the
quota, he gets the Price of the quota, Pq. Hence in equilibrium it must be the case that the Price of
the quota equals the profits that the firm makes by producing.
Head tax that has not have an impact/change on quantity or number of people that live there
There will be no deadweight loss if there the head tax does not have an impact on anything.
