Test #2 (chapters 5-8)

Question 1

If raising the price of donuts 12% leads to a rise in quantity supplied by 16%, what is the PES

Answer 1

12 / 16 = 1.33

Question 2

What makes supply elastic?

Answer 2

When the percentage change in quantity supplied is larger than the percentage change in price –> greater than 1

Question 3

What are the determinants of the price elasticity of supply?

Answer 3

1. Inventories make supply more elastic
2. Easily available variable inputs (ex. unskilled labour = more elastic)
3. Extra capacity makes supply elastic (ex. restaurant capacity)
4. Easy entry and exit make supply more elastic
5. Over time, supply becomes more elastic

Question 4

What is the difference between a tax on buyers and a tax on sellers?

Answer 4

On buyers : the sticker price does not include the tax - you pay at checkout

On sellers : the sticker price includes the tax but the seller doesn’t keep that full amount

** as buyers and sellers you’re still paying and keeping the same amount either way

Question 5

What is the statutory burden?

Answer 5

The burden of being assigned by the government to send a tax payment. Pretty much irrelevant - just says whether the tax is put on the buyer or seller (tax shown in sticker price or not shown in sticker price)

Question 6

What is the economic burden and the tax incidence?

Answer 6

Economic burden = the burden created by the change in the after-tax prices faced by buyers and sellers

Tax incidence = the division of the economic burden of a tax between buyers and sellers

• these depend on the elasticity - if the buyers are very inelastic, the sellers may push more of the tax burden onto the consumers

Question 7

The tax incidence does not depend on the ________, it depends on the __________

Answer 7

Statutory burden

Elasticity

Question 8

The ________ inelastic your curve, the more of the tax burden you will bear

Answer 8

more

Question 9

What is a subsidy?

Answer 9

A payment made by the government to those who make a specific choice

It acts just like a tax, but it is the opposite

Increases quantities demanded and supplied rather than decrease
They also lower the price to buyers and increase the price sellers receive

Question 10

With a subsidy, the more _________ party captures more of the benefits

Answer 10

inelastic

Question 11

What is a price ceiling? What makes it binding?

Answer 11

A maximum price that sellers can charge that is set by the government

It is binding if it is below the equilibrium price - makes it impossible to reach the market equilibrium price

Question 12

What is a price floor? What makes it binding?

Answer 12

A minimum price that sellers can charge that is set by the government

It is binding if the floor is set above the equilibrium price

Question 13

What are two reasons the government may want to set a binding price floor?

Answer 13

1. They want to help sellers (minimum wage)
2. The want to reduce the quantity sold in the market (ex. alcohol)

Question 14

What is a mandate? What makes it binding and what is an example?

Answer 14

A requirement to buy or sell a minimum amount of a good

Binding when the required quantity is greater than the equilibrium quantity

ex. a health insurance mandate requires consumers to purchase health insurance
ex. a housing mandate requires developers to build a certain amount of low-income housing

Question 15

What is a quota? What makes it binding and what is an example?

Answer 15

A limit on the maximum quantity of a good that can be bought or sold

Binding when the quantity is less than the equilibrium quantity

ex. limit the amount of marijuana you can buy
ex. taxi quota

Question 16

What is the difference between positive and normative analysis?

Answer 16

Positive = describes what is happening, explaining why, or predicting what will happen
“what will happen if we adopt this policy?

Normative analysis = Determines what SHOULD happen, which involves opinion and value judgements
“what policy should the government adopt?”

Question 17

What determines economic efficiency?

Answer 17

The more economic surplus if yields, the more economically efficient it is

Question 18

What is economic surplus? (equation)

Answer 18

The total benefits minus total costs flowing from a decision - how much the decision improved your well-being

It is the sum of the consumer surplus plus the producer surplus
(marginal benefit - marginal cost)

Question 19

What is consumer surplus?

Answer 19

The marginal benefit - the price
(marginal benefit = the willingness to pay for that item)

The gain from buying something at a price below the highest price you were willing to pay

Question 20

You are willing to pay $5 for a cup of coffee and it is $3. What is your consumer surplus?

Answer 20

$2!

Question 21

Where is the consumer surplus situated on the graph?

Answer 21

It is the area below the demand curve but above the price

Question 22

What is producer surplus?

Answer 22

Price - Marginal Cost
(marginal cost = the extra cost from one extra unit)

The gain from selling something at a price above the marginal cost you incur from producing that good or service

Question 23

Where is producer surplus situated on the graph?

Answer 23

It is above the supply curve but below that price

Question 24

_______ based economics yield more efficient outcomes than _________ planned economies

Answer 24

Market

Centrally

Question 25

What is efficient production?

Answer 25

Producing each unit at the lowest marginal cost

Question 26

What is efficient allocation?

Answer 26

Allocating goods to create the largest economic surplus Each good has to go to the person who will get the highest marginal benefit from it

Question 27

What is efficient quantity and the rational rule for markets?

Answer 27

Efficient quantity = the quantity that produces the largest possible economic surplus RR for markets = produce more of a good if its marginal benefit is greater than (or equal to) the marginal cost

Question 28

Define market failure

Answer 28

When market forces of supply and demand lead to an inefficient outcome

Question 29

What are the five main sources of market failure?

Answer 29

1. Market power 2. Externalities 3. Information problems 4. Irrationality 5. Government regulations

Question 30

What is market power as a market failure?

Answer 30

If a market doesn't have lots of sellers selling the same product then sellers can exploit the limited competition and charge higher prices. This means consumers will buy less and less than the efficient quantity is produced

Question 31

Describe an externality

Answer 31

When the choices buyers and sellers make have side effects on others ex. someone smoking a cigarette near you means you have the side effect of second-hand smoke when this isn't taken into consideration, more than the efficient quantity ends up getting bought and sold

Question 32

Describe information problems as a market failure

Answer 32

Deals with private information - information that one party has but the other doesn't ex. selling a used car - you might wonder what they know that you don't and that might make you not buy the car even though you should

Question 33

What is irrationality as a market failure?

Answer 33

When buyers or sellers do not follow their rational rules - decisions not driven by their marginal benefits and costs

Question 34

Describe government regulations as a market failure

Answer 34

When governments impede market forces ex. taxes can lead to lower quantities being bought and sold *sometimes these can correct a market failure and sometimes they can create one

Question 35

What is deadweight loss? (equation)

Answer 35

How far economic surplus falls below the efficient outcome Economic surplus at efficient outcome - actual economic surplus

Question 36

What are government failures

Answer 36

When the government policies lead to worse outcomes and less economic efficiency

Question 37

What is the role of distributional consequences?

Answer 37

Not just about picking the largest economic pie but also about how the pie is sliced Determining who gets what and assessing whether the outcome seems fair or equitable

Question 38

What are the five ways that price ceilings can cause inefficiency?

Answer 38

1. Inefficiently low quantity 2. Inefficient allocation to customers 3. Wasted resources 4. Inefficiently low quality 5. Black markets

Question 39

What are the 4 ways that a price floor can cause inefficiency?

Answer 39

1. Deadweight loss from inefficiently low quantity 2. encourage waste 3. inefficient allocation of sales among sellers 4. Inefficiently high quality

Question 40

What are the inefficiencies that can come from a minimum wage?

Answer 40

1. Deadweight loss from inefficiently low quantity 2. Inefficient allocation of employees 3. Inefficiently high quality 4. Temptation to break the law by selling at lower price

Question 41

What is the difference between absolute and comparative advantage?

Answer 41

Absolute = the ability to do a task using fewer inputs (who is best at the task) Comparative = the ability to do a task at a lower opportunity cost - they will give up less to do this task than the other person (who should do the task)

Question 42

When comparing the comparative advantage of two people's tasks, what should you convert the units to?

Answer 42

Make tables of how many of that task the person could do within a specific amount of time

Question 43

What is specialization?

Answer 43

Focusing on the task in which you have a comparative advantage - ensures each task is done at the lowest opportunity cost

Question 44

How does comparative advantage drive international trade?

Answer 44

One country will produce what they're good at producing and they will buy everything else from others

Question 45

How can price be described as a signal

Answer 45

Signal to potential suppliers about how much buyers value a good - revealing their marginal benefit Signal to potential buyers about how expensive it is for sellers to produce more of a product, revealing the seller's marginal cost

Question 46

Describe price as an incentive

Answer 46

High price is an incentive for sellers go produce more and buyers to buy less (consider switching to alternative)

Question 47

What are prediction markets?

Answer 47

Markets whose payoffs are linked to whether an uncertain event occurs

Question 48

Are north and south Korea centrally planned or market economies?

Answer 48

North = centrally planned (average income is much less) South = market economy (average income is much more)