Part 3 [Supply and Demand II] - 7. Consumers, Producers, and the efficiency of markets - 8. application: the cost of taxation - 9. application: international trade Flashcards
What is welfare economics?
The study of how the allocation of resources affects economic well-being.
What is someone’s willingness to pay?
The maximum amount that a buyer will pay for a good.
What is consumer surplus?
A buyer’s willingness to pay minus the amount the buyer actually pays.
What does consumer surplus measure?
The benefit to buyers of participating in a market.
What is consumer surplus closely related to?
The demand curve for a product.
What is important to note amount the relationship between the height of a demand curve and a buyer’s willingness to pay?
At any quantity, the price given by the demand curve shows the willingness to pay of the marginal buyer, the buyer who would leave the market first if the price was any higher.
How is consumer surplus graphically represented/measured?
The difference between the willingness to pay and the market price is each buyer’s consumer surplus. Thus, the total area below the demand curve and above the price is the sum of the consumer surplus of all buyers in the market for a good or service.
How does a lower price increase consumer surplus?
First, those buyers who were already willing to buy at the higher price are better off because they now pay less.
Second, some new buyers enter the market because they are now willing to buy a good at the lower price.
Why is consumer surplus a good measure of economic well-being if policymakers want to respect the preferences of the buyers?
Because it measures the benefit that buyers receive from a good as the buyers themselves perceive it.
What is cost?
The value of everything a seller must give up to produce a good.
Why is cost a measure of a producers willingness to sell?
Because the producers cost is the lowest price they would accept for their product.
What is producer surplus?
The amount a seller is paid for a good minus the seller’s cost.
What is important to note amount the relationship between the height of a supply curve and a seller’s costs?
At any given quantity, the price given by the supply curve shows the cost of the marginal seller, the seller who would leave the market if the price was any lower.
How is producer surplus graphically represented/measured?
The height of the supply curve measures seller’s costs, and the difference between the price and the cost of production is each seller’s producer surplus. thus, the total area is the sum of the producer surplus of all sellers.
How does a higher price increase producer surplus?
First, those sellers who were already willing to sell at the lower price are better off because they now get more for what they sell.
Second, some new sellers enter the market because they are now willing to produce the good at the higher price.
What is total surplus and how is it measured?
A market’s economic well-being measured as the sum of consumer and producer surpluses.
Total surplus = Value to buyers - Cost to sellers
What is efficiency in terms of total surplus?
The property of a resource allocation of maximizing the total surplus received by all members of society.
What is equity?
The fairness of the distribution of well-being among the members of society.
How is total surplus graphically represented?
As the total area between the supply and demand curves up to the point of equilibrium.
How are resources allocated efficiently in equilibrium?
- Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay.
- Free markets allocate the demand for goods to the sellers who can produce them at least cost.
- Free markets produce the quantity of good that maximize the sum of consumer and producer surplus.
Why don’t centrally planned economies usually work very well?
The social planner would need to know the value of a particular good to every potential consumer int he market and the cost of every potential producer. And he would also need this information not only for this market but for every one of the many thousands of markets in the economy. This task is practically impossible.
How do market failures prevent some unregulated markets from allocating resources efficiently?
- Market power can cause markets to be inefficient because it keeps the price and quantity away from the equilibrium of supply and demand.
- Externalities cause welfare in a market to depend on more than just the value to the buyers and the cost to the seller.
How can we better understand how taxes affect economic well-being?
By comparing the reduced welfare of buyers and sellers to the amount the government raises.
How is tax revenue calculated?
T x Q
Where T is the size of the tax and Q is the quantity of the good sold.
How is tax revenue represented graphically?
As the area of the rectangle in between the demand and supply curves with height equal to the size of the tax and width equal to the quantity of gods sold under said tax.
How is total surplus calculated in the market for a taxed good?
By summing the consumer surplus, the producer surplus, and the tax revenue.
What is deadweight loss?
The fall in total surplus that results from a market distortion, such as a tax.
How is a deadwight loss from a tax calculated?
As the difference between the change in consumer and producer surplus (negative) and the revenue raised by government (positive).
