Midterm 2 Flashcards
Graphically, whats the total consumer surplus?
Area below the demand curve but above the price
How does rise in price affect consumer surplus?
Decreases it
Graphically, what’s the total producer surplus?
The area above the supply curve but below the price
How does a rise in price affect producer surplus?
Increases it
(but different for each individual producer)
Attempts to create another arrangement which produces a higher total surplus [3]
- Reallocate consumption among consumers
- Reallocate sales among sellers
- Change the quantity traded
Do any of these alternatives work?
No. they all ultimately decrease total surplus
Why does reallocating consumption among consumers fail?
you would be taking away from a person who values it more and is therefore willing to pay to give to someone who values it less
–> decreases consumer surplus
Why does reallocating sales among sellers fail?
Takes sellers away from sellers who would’ve sold their books at market equilibrium to compel those who would not have sold their prices
–> Thus producer surplus is decreased
Why does changing the quantity traded fail?
If u try to trade more or less goods than the market eq quantity, less transactions will occur
–> Thus total surplus is decreased
An efficient market … [4]
- Allocates consumption of the good to the potential buyer who will pay the most
- Allocates sales to seller who have the lowest cost
- Ensures that every consumer values the good sold more than the producers so that all transactions are mutually beneficial
- Ensures that every potential buyer who doesn’t purchase values the good less than any seller who doesn’t make the sale
Why do markets work so well?
- Property rights
- Economic signals
What causes market failure?
- Market power / monopoly
- Externalities
[When actions have side effects on the welfare of others, such as pollution as a negative byproduct for many of the goods sold in markets] - Public goods, common resources
- Insider info
What happens when governments intervene in markets?
They defy the principle that markets move towards equilibrium
Assumption when handling price floors and ceilings
- Markets in question were efficient pre price controls
When is a price ceiling binding?
When the price ceiling is below the equilibrium price
Whats the issue (graphically) with price ceilings?
Lower price makes it so that producers have less incentive to sell (reduces supply) but demand is still increasingly high
Do price ceilings lead to shortages or surplus?
Shortages
Inefficiencies Caused by Price Ceilings [4]
- Inefficiently low quantity traded
- Inefficient allocation of resources
- Wasted resources
- Lower quality of goods
Innefficiently low quantity
- with price ceilings, total surplus decreases
- DWL increases since beneficial transactions aren’t taking place
Inefficient allocation of resources
- those that are more desperate for a good would be willing to pay more but they cant bc of price ceilings
- so the distribution of goods is random at best
Waste of resources
In particular time and effort looking for the newly scarce goods
Lower quality goods
Sellers offer low-quality goods at a low price (bc they literally cant) though byers would rather have a higher quality product and pay a higher price
Why price controls then?
- Benefit SOME people
- Might be hard to get rid of them if they’ve been there for too long
- Gov officials don’t understand econ
When is a price floor binding?
When the eq price is lower than the one set
Whats the issue with price floors?
- Excess supply, producers produce a lot but demand is not as high since prices are
What inefficiencies are caused by price floors?
- Inefficiently low quantity
- Inefficient allocation of resources
- Wasted resources [esp due to surplus]
- Needlesly high quality of goods
1-3 are the SAME as when price ceilings
Inefficiently high quality
Supplies offer goods of inefficiently high quality to justify higher prices where buyers don’t always want the higher quality, just want lower prices
So why price floors?
- Benefit SOME producers
- Gov officials don’t know econ
What is the price elasticity for demand
The ratio of the percent change in quantity demanded to the percentage change in price as we move along the demand curve
Midpoint method for Price elasticity for demand
%△Qd /
%△P
*%△ = Qnew-Qold / (Qn + Qo)/2
What does ‘elastic’ mean?
The response to a change in price will be proportional - Price goes up, demand will go down
What does ‘inelastic’ mean?
The response to a change in price will not be proportional - Price goes up, demand stays the same
If PE Is greater than 1…
ITs elastic
IF PE is 1…
ITs unit elastic
If PE is smaller than 1…
Its inelastic
Formula for total revenue
Price x Quantity
If demand is unit-elastic and price changes, total revenue will…
Not change
If demand is elastic, and price changes, total revenue will
- If higher price, will go down
- If lower price, will go up
If demand is inelastic, and price changes, total revenue will..
- If higher pricer, it will go up
- If lower price, it will go down
What factors determine the price elasticity of demand?
- Whether the good is a neccesity or luxury
- The availability of close resources (if many available, elasticity will be higher)
- Share of income spent on the good (greater income share = higher elasticity)
- Time elapsed since price change (longer time = higher elasticity)
What is cross-price of demand?
How demand for a good is affected by price of other goods
What is income elasticity of demand?
How demand is affected by changes in income
What is price elasticity of supply?
Same as demand but with supply lol
Formula for cross-price
%△ in quantity of A demanded /
%△ in price of B
When 2 goods are subsitutes…
Positive cross-price elasticity
When 2 goods are complements…
Negative cross-price elasticity
Formula for Income elasticity
%△ in quantity demanded /
%△ in income
If a good is normal …
Income elasticity is positive
If a good is inferior…
Income elasticity is negative
If income-elasticity is greater than 1…
Income elastic normal good
If income-elasticity is less than 1…
Income inelastic normal good
Formula for price elasticity of supply
%△ quantity supplied /
%△ in price
*Same numbers for interpretation as demand
Factors determining price elasticity of supply
- Availability of inputs [If more are available, more elastic]
- Time [long-run = larger elasticity]
Price net of tax formula
Pp = Pc - T
What does the incidence of a tax depend on?
The elasticity of both supply and demand
what happens if the PE for demand is low and PE for supply is high?
Burden of tax falls on consumers
What happens if the PE for demand is high and PE for supply is low?
Burden of tax falls on producers
Is the relationship between tax rates and revenue 1-for-1?
NO!!!
Setting a tax too high or lowering a already high tax will likely deter a good amount of transactions, decreasing revenue
Cost of taxation
- Opp cost from the many mutually beneficial transactions that could’ve happened without the tax
–> DWL
What happens to the DWL if the price elasticity of supply or demand is high?
The DWL is also larger
If inelastic, will be smaller
Which is better: Lump-sum tax or proportional taxes?
- Proportional taxes SEEM more reasonable since they’re fairer
- But actually 🤓 proportional taxes tend to reduce production, resulting in lower income
- whereas LS tax doesn’t impact incentives
3 Types of tax structure
- Proportional = Flat, same % regardless
- Progressive = More $ more tax
- Regressive = More $ less/equal tax
What do economists use to compare incentive effect?
Marginal tax rate
Which is better - progressive or recessive system
- Again, progressive might seem better bc its more fair
- But its actually kinda counter-productive in some things bc they take away incentives from getting more money :/
