ppt 4-5, 8-9: market efficiencies, elasticity Flashcards
welfare economics
the study of how the allocation of resources affects economic well-being
what is the consumer surplus (CS) equation?
(value to buyers) - (amount paid by buyers) = buyers’ gains from participating in the market
the area below the demand curve and above the price measures the consumer surplus in a market
what is the producer surplus (PS) equation?
(amount received by sellers) - (cost to sellers) = sellers’ gains from participating in the market
the area below the price and above the supply curve measures the producer surplus in a market
what is the total surplus?
CS + PS = total gains from trade in a market = (value to buyers) - (cost to sellers)
Calculate the total surplus using seventeen concert tickets as an example, in which the market equilibrium is $400 at 4000 tickets sold, and the highest price willing to be paid is $600. Cost to producer is $100.
as a consumer, I benefit if I pay less than the amount that I would’ve been willing to pay for. i.e. i’d pay upwards of $600 for svt vip tickets, but only paid $400. Therefore my CS is $200. Multiplied by 4000 carats in vancouver for example who do the same thing, the CS for svt vip tickets is $800,000
For the producers, they receive $400 but it only costs them $100 a head at 4000 heads. Therefore the PS is (400-100) * 4000 = $1,200,000
The total surplus is 1.2mil + 80k = $2,000,000
when might consumer surplus be of good economic well being vs. poor economic well being?
good for the average consumer, who gets to benefit! bad for the well being of drug addicts for example, because we don’t want them to be buying more heroin as addicts are not looking after their own best-interests . most of the time however, consumer surplus does reflect economic well being
efficiency
the property of a resource allocation of maximizing the total surplus received by all members of society
aka u should be resource-maxxing
what is the efficiency of the equilibrium quantity as the quantity increases and decreases?
Quantities < equilibrium = value of buyers > cost to sellers
Quantities > equilibrium = value of buyers < cost to sellers
Therefore, the market equilibrium maximizes the sum of producer and consumer surplus (total surplus)
why do economists often advocate for free markets as the best way to organize economic activity?
because in a free market (laissez-faire), the equilibrium already provides the maximum benefit (surplus) to economic well being.
AKA, The invisible hand of the market has already guided buyers and sellers to an allocation of economic resources that maximizes to total surplus.
exWhat are two assumptions that may not hold when considering the efficiency of the market equilibrium?
- that the outcome in a market only matters to buyers and sellers of the market (it may affect those who are not participating, i.e. pollution as a side effect affecting non-market participants) -> these side effects are called externalities
- assumption is that markets are perfectly competitive, but in reality they may not be. there may be monopolies or firms with high market power that causes markets to be inefficient because it keeps the price and quantity away from the equilibrium
what are some examples of market failure?
externalities (side effects) + market power
willingness to pay (WTP)
aka value to buyer in CS and PS
elasticity
a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants
price elasticity of demand
a measure of how much the quantity demanded of a good responds to a change in the price of that good
what does it mean for a good to be elastic vs. inelastic?
elastic: quantity demanded responds substantially to changes in the price, i.e. bubble tea
inelastic: quantity demanded responds only slightly to changes in the price i.e. gas prices (in the s/t) -> you will still need gas
think of elastic like a rubber band: super susceptible to change!
what are some of the determinants of elasticity?
necessities vs. luxuries, availability of close substitutes, definition of the market, time horizon
how do definitions of markets impact elasticity?
more broad = less elastic i.e. food -> no substitutes for food
more narrow = more elastic i.e. ice cream -> vanilla ice cream -> abundance of flavour/ice cream substitutes
how do you calculate price elasticity of demand?
(percentage change in quantity demanded) / (percentage change in price) -> WILL ALWAYS BE POSITIVE (use absolute values if needed)
what does the number computed from the elasticity of a good mean? how is this represented on a graph?
E => 1 = elastic (where =1 means unit elasticity)
E < 1 = inelastic
The flatter the curve, the more elastic. The steeper the curve, the less elastic.
what is an issue with calculate percentage change and elasticities through two points on a demand curve? what is a better method?
elasticity from point A to B may differ from point B to A.
The better way is to use the midpoint method!
midpoint method calculation
(Q2-Q1)/[(Q2+Q1)/2] / (P2-P1)/[(P2+P1)/2]
how does total revenue change when price changes in relation to elasticity?
when there’s inelastic demand, increase in price = increase in revenue and vice versa
when there’s elastic demand, increase in price = decrease in revenue and vice versa
income elasticity of demand
how the quantity demanded changes as consumer income changes
how do we calculate income elasticity of demand?
(percentage change of quantity demanded) / (percentage change in income)
what is the relationship between normal/inferior goods and income elasticity?
normal goods: positive income elasticities (higher income = more quantity demanded)
inferior goods: negative income elasticities (higher income = less quantity demanded)
cross-price elasticity of demand
how much the quantity demanded of one good responds to a change in the price of another good
how to calculate the cross-price elasticity of demand?
(percentage change in quantity demanded of good 1) / (percentage change in quantity demanded of good 2)
how does a policy aimed at reducing the supply of farm products impact consumers and farmers?
increases income for farmers since wheat has an inelastic demand, but harms consumers who now need to pay more as prices rise
how might drug interdiction policies affect supply and demand curves? how might it impact drug use vs. drug-related crimes?
supply goes down as more suppliers are arrested, etc. -> price increases -> less drug use
however, DEMAND for drugs have not changed (drugs have inelastic demand)
increased prices -> more need for existing drug users to find ways to get quick cash -> more drug-related crimes
important to note that this could differ in short run vs. long run
how do we calculate the price elasticity of supply?
(percentage change in quantity supplied) / (percentage change in price)
t or f: in most markets, supply is more elastic in the short run over the long run
false. more elastic in long-run i.e. gas prices inelastic in the short run, but in the long run if it stays at high prices consumers will shift to using more EVs etc.
For substitutes, is cross-price elasticity greater than or less than 0? Why?
greater than 0 -> increase in price of beef increases demand for chicken instead since they are easily swapped
For complements, is cross-price elasticity greater than or less than 0? Why? (Assuming no absolute values)
less than 0 -> increase in price of computers decreases demand for software since you won’t have the computer to go with it
If a firm lowers the price of a product, would total revenue go up or down in relation to elasticity?
If the good is inelastic (E<1), total revenue will also go down. P + TR move in the same direction.
If the good is elastic (E>1), total revenue will go up (negative correlation). P + TR move in opposite directions.
