Normative Analysis of Perfect Competition Flashcards
What is positive economics?
Describes how markets behave (e.g “firms maximise profit”)
What is normative economics?
Judges whether those outcomes are good or bad - using welfare as the main criterion
How do we measure Welfare?
Total Surplus (TS) is used
What is the equation for Total Surplus?
Total Surplus = Consumer Surplus + Producer Surplus + (Government revenue if any)
What is consumer surplus (CS)?
Value consumers get above what they pay
What is producer surplus (PS)?
Value producers receive above their cost
What is Government revenue?
From taxes or minus subsidies is added if applicable
How does Perfect competition maximise Welfare?
At a perfectly competitive equilibrium ( D=S)
output is Q* and price is P*
- This maximises total surplus
- There is no deadweight loss
Its pareto efficient - no one can be made better off without making someone worse off
name a criticism of using surplus as a good measure
A £1 gain to a low income consumer may be more valuable then to a wealthy producer
there is no weighting or income, equity or fairness in surplus
What is a price ceiling?
When a maximum price is set below the equilibrium rent
For example, if P1 is the market rent and PR < P1 is imposed as a cap
How does a price ceiling impact Consumer welfare?
They gain some because they pay less rent
How does a price ceiling impact Producer welfare?
Loss of revenue which decreases producer surplus
How does a price ceiling impact Total supply?
This falls and creates a shortage
How does a price ceiling impact Total surplus?
This falls due to inefficient allocation and fewer housing using available
What is deadweight loss?
it is the loss of total surplus (welfare) that occurs when a market is not operating efficiently
it represents the value of goods not bought or sold because the market is being stopped from reaching natural equilibrium
Why does dead weight loss matter?
It is a signal of under-producing or misallocating resources, it means that someone could be better off without making anyone worse off.
What is an example of a price ceiling?
The government can set a cap on rent, some renters benefit and some dont.
in practice, allocation becomes random which adds unfairness and inefficiency
What determines where the burden of tax falls?
the burden of tax is dependent on the relative elasticises of demand and supply
Who burdens the incidence of tax with inelastic supply?
The producer bears most of the tax
Who burdens the incidence of tax with inelastic demand?
Consumers bear most of the tax
Why are taxes not efficient?
A tax reduces the total surplus and creates deadweight loss
How can taxes be used for good and counter the deadweight loss?
Taxes raise government revenue.
These revenues can be used to benefit society in theory
