Econ Test 2

Taxes

Reduce the quantity sold in a market, and the burden is often shared by buyers and sellers (depends on elasticity of supply or demand)

Dead weight loss

In most cases, taxes create this, but taxes can also reverse this if they are used to internalize externalities

Incentives

Taxes create these, which people respond to

Efficiency and equity

Two objectives of policymakers when designing a tax system

Dead weight loss

This will distort the decisions taxpayers make; represents market inefficiency that occurs dur to the tax incentives and not from the original cost or benefit analysis that might have occurred

Deadweight loss

Total surplus - Tax revenue

Administrative burdens

Burdens the taxpayers bear as they comply with the tax laws

Ability to pay principle

Taxes should be levied on a person according to how well that person can shoulder the burden

Vertical equity

Taxpayers with greater ability to pay taxes should pay larger amounts; marginal tax rates that increase with income

Horizontal equity

Taxpayers with similar abilities should contribute similar amounts; tax brackets arranged by income levelT

Benefits received principle

People who benefit from something should pay for it with taxes

Personal income tax

Largest source of tax revenue for the federal government; based on total income

Marginal tax rate

Tax applied to each additional dollar of income

Payroll taxes

A tax on wages a firm pays its workers

Corporate income tax

A tax on profits

Proportional tax

High income and low income taxpayers pay the same amount (often considered regressive)

Regressive tax

High income taxpayers pay a smaller fraction of their income than do lower income taxpayers (ex. sales tax)

Progressive tax

High income taxpayers pay a larger fraction of their income than do lower income taxpayers (ex. US income tax)

Average tax rate

to determine if a tax is progressive, proportional, or regressive, we need to calculate the average tax rate

Average tax rate

(Tax amount / Income) x 100

Utility

In the free market, consumers try to maximize this given:

• Preferences

• Price of other items

• Budget

Costs and benefits

Much of economics is about comparing these two things associated with an activity; can sometimes be measured in objective terms, but can be difficult to measure benefits

Marginal utility

The additional satisfaction or happiness received from the consumption of an additional unit of a good/service

Marginal utility

Change in Total Utility / Change in Quantity

Total utility

Total satisfaction or happiness received from the consumption of a good or service, or a combination of goods and services

Total Utility

Sum of marginal utility

Law of diminishing marginal utility

The marginal utility associated with consumption of a good/service becomes smaller with each extra unit that is consumed in a given period of time

Negative

If total utility is decreasing, marginal utility is:

Maximizing utility

The process of obtaining the greatest level of overall satisfaction from consuming goods and services, subject to consumers’ preferences, incomes, and prices

Rational behavior

Consumers attempt to maximize their satisfaction

Ranked preferences

Consumers are able to rank their preferences

Limited income

Consumers can only buy the goods/services allowed by their limited income

Prices

Allow consumers to know how much they can consume within their limited income

Equal marginal principle

Consumers maximize their utility when they allocate their limited incomes so the marginal utility (per dollar spent) on each of their final choices in a bundle is equal (MUa/Pa = MUb/Pb)

Maximizing profit

The number one priority for most firms

Theory of the firm

Economists start by assuming firms seek to maximize their profits

Profit

Total revenue - costs

Explicit cost

a direct cash outlay for resources (can see in a checking account)

Implicit cost

Opportunity cost of resources owned by the firm (can’t see in a checking account)

Opportunity cost of capital

Basic economic principle: the cost of something is what you give up to get it

Explicit revenue

A direct cash inflow from selling a good/service (can see in a checking account)

Implicit revenue

An increase in the value of assets (can’t see in a checking account)

Accountants

Keep track of money that flows in and out

Economists

Study some costs and revenues that, though real, are hard to quantify

Accounting profit

Explicit revenue - explicit costs

Economic profit

(Explicit revenue + implicit revenue) - (explicit cost + implicit cost)

Basic task of a firm

To take inputs of production and turn them into goods and services

Production function

Relationship between quantity of inputs used to make a good and quantity of output of that good

Marginal product

The increase in output that arises from an additional unit of input

Law of diminishing product

As the quantity of an input/variable resource increases, marginal (or additional) product/returns eventually goes down

fixed resources

Resources that don’t change as you produce more

Variable resources

Resources that do change as you produce more

Decrease

As you add variable resources to fixed resources, productivity will eventually:

Total product

The total amount of output produced with a given number of resources

Average product

the average amount of output produced per unit of a resource used

Fixed costs

Costs that do not vary with the quantity of output produced

Variable costs

Costs that vary with the quantity of output

Total costs

The sum of fixed costs and variable costs

Total cost curve

The relationship between the quantity of output produced and the total cost of production (gets steeper - reflects diminishing marginal product)

Average total cost

Total cost divided by the quantity of output (TC/Q)

Average fixed cost

Fixed cost divided by the quantity of output (FC/Q)

Average variable cost

Variable cost divided by the quantity of output (VC/Q)

Marginal cost

The increase in total cost that arises from an extra unit

Average fixed cost

Always declines as output increases because the fixed cost is getting spread out over a larger number of units

Average variable cost

Usually only rises as output increases because of diminishing marginal product

Efficient scale of the firm

The bottom of the U-Shape for ATC that occurs at the quantity that minimizes ATC

U-Shape

The tug of war between AFC and AVC causes this in the ATC

efficient scale

AFC and ATC balance to produce the lowest ATC

Falling

When marginal cost is less than ATC, ATC is:

Rising

When marginal cost is greater than ATC, ATC is:

short-run

a time period so short that at least one of the firm’s resources is fixed

long-run

in this time period, all resources can be varied

Flexibility

Firms have more of this during the long run, so they can choose which short-run curve it wants (in the short run, it must use whatever short-run curve it has)

Economies of scale

Long-run ATC falls as the quantity of output increases

Diseconomies of scale

ATC rises as quantity of output increases

Constant returns to scale

When long-run ATC does not vary with the level of output

Specialization

Economies of scale often arise because higher production levels allow this among workers, which permits each worker to become better at their task

Diseconomies of scale

Arise because of coordination problems that often occur in large corporations (more a company produces, the more stretched management becomes and the less effective they might become)

perfectly competitive market

a market structure characterized by the interaction of a large number of buyers and sellers, in which the sellers produce a standardized product (sellers are price takers)

characteristics of competitive markets

1. there are many buyers and sellers

2. goods are largely the same

3. buyers and sellers are price takers (must accept the market price)

4. firms can freely enter or exit the market (no barriers to entry)

Efficiency

this is crucial to a perfectly competitive market

total revenue

price x quantity

average revenue

total revenue / quantity

marginal revenue

change in total revenue / quantity

competitive firms

Average revenue = price

Marginal revenue = price

price takers

because there are so many firms producing the same product, perfectly competitive firms sell each unit at the equilibrium price - the production of a single firm cannot affect the price (the demand curve is the same as the MR curve)

Increase production

If marginal revenue > marginal costs, the firm should:

Decrease production

If marginal revenue < marginal cost, they should:

profit maximization

occurs when Marginal revenue = marginal cost

horizonal

Price is a _____ line for perfectly competitive markets because it is perfectly elastic

Market

For firms in perfectly competitive markets, price is determined by this

shutdown

a short-run decision not to produce anything during a specific period of time because of current market conditions

Exit

long-run decision to leave the market

Produce at a loss

What should a firm do if AVC < P < ATC?

Shutdown

What should a firm do if P < AVC

Fixed cost

A firm that shuts down temporarily still has to pay these costs

Economic loss

The area between the AVC and ATC - where firms will take losses but continue to operate

Sunk costs

A cost that has already been committed and cannot be recovered

Revenue

A firm should exit the market if the ______ it would get from producing is less than the total costs of production

ATC

In the long run, if price is lower than this, firms should/will exit the market