Econ B-251 IU Exam 2

when demand is more inelastic, ______________ pay more of the tax

consumers

when demand is more elastic, ______________ pay more of the tax

producers

when demand is unit elastic, consumers and producers pay _____________ of the tax

the same amount

protectionism

regulations that burdens foreign producers but not domestic producers

tariff

tax on imports

trade quota

restriction on the quantity of foreign goods that can be imported

tariffs raise ______________ for _______________

tax revenue, the government

tariffs increase _____________________ and decrease _____________________

domestic production, domestic consumption

a restriction on trade wastes __________________ and creates ___________________ from trade

resources, lost gains

3 conditions why a free market is efficient

1) supply of goods is bought by buyers with the highest willingness to pay

2) supply of goods is sold by the sellers with the lowest costs

3) between buyers and sellers, there are no unexploited gains from trade or any wasteful trades

tariffs reduce _________ because the supply of goods is no longer sold by the sellers with the ___________________________

efficiency, lowest costs

the more __________ the market, the more they can escape taxes

elastic

the more ______________ the market, the more they are burdened by taxes

inelastic

the optimal tariff balances increase in ______________ with increase in ____________

deadweight loss, revenues

social cost

private cost + external cost

external cost

a cost that is paid not by consumers or producers, but

by bystanders to the transaction

when externalities are significant,

markets work less

social surplus

consumer surplus + producer surplus + everyone else's surplus

markets with externalities DO NOT

maximize social surplus

market equilibrium

maximizes consumer plus producer surplus

efficient equilibrium

the price and quantity that maximizes social surplus

when external costs are significant,

output is too high

Qmarket > Qefficient

a tax set equal to the level of external costs would:

-shift supply up so that it overlays the social cost curve

-market quantity would fall from q market to q efficient

-market equilibrium would be the efficient equilibrium

a tax on a good with an external cost reduces ___________ and raises ____________

deadweight loss, revenue

external benefit

benefit to people other than consumers or producers trading in a market (i.e. vaccines)

when external benefits are significant,

market output is too low

a subsidy on a good with an external benefit will reduce ____________, increasing _____________

deadweight loss, social surplus

internalized costs/benefits

adjusting incentives so that decision makers take into account all the benefits and costs of their actions, private and social

transaction costs

all the costs necessary to reach an agreement (i.e. bargaining, contracts, etc.)

coase theorem

if the transaction costs are low and property rights are clearly defined, then private bargains will ensure the market equilibrium is efficient even when there are externalities

command and control

when the government orders firms to do something to reduce externalities

command and control is effective when

the best approach to a problem is well known and if success requires very strong compliance

tradable allowance

a production or consumption quota that can be bought and sold

a tax set equal to the level of the external cost is equivalent to

tradable allowances

to achieve efficient equilibrium,

govt can uses taxes to raise price to efficient price or use allowances to reduce quantity to efficient quantity

external costs

negative externalities

external benefits

positive externalities

private cost

a cost paid by the consumer or the producer

subsidies

reduce deadweight loss and increase social surplus

market equilibrium fails to

internalize the external cost

efficient quantity

quantity that maximizes social surplus

Pigouvian Tax

a tax on a good with external costs, reduces deadweight loss and raises revenue

alternative to a pigouvian tax

regulate quantity

danger of pigou

could lead to less efficient outcome rather than fixing the inefficiency caused by the externality, misses opportunity cost

Coasian Solution

externalities are reciprocal in nature, not from one person's actions, but the combined actions of 2+ parties

property rights

right to use, sell, lease, and/or bequeath an asset

if transaction costs are 0,

then it does not matter who has the property right, people will trade

when transaction costs are high

the regulator or court should give the right to whomever will maximize social benefits

income effect of the coase theorem

it is always better to have the initial property right and sell it

price takers

In a competitive market, producers must accept the price determined by the market

long run

time after all exit/entry has occurred

short run

time period before exit or entry can occur

demand is most elastic in the ________________

long run

explicit cost

requires a money outlay

implicit cost

does not require an outlay of money, opportunity cost

general principle of rational cost

ignore what you can't change, focus on what you can change

sunk cost

nonrecoverable cost

sunk cost fallacy

why change now? We've already wasted so much money

fixed costs

don't vary with output, can't be changed by short run choices, should be ignored in short run (only matter in long run)

variable costs

vary with output

firms will enter an industry when

P>AC

firms will exit an industry when

P

P=AC

profits are 0, no incentive to enter or exit. normal profits, price is just enough to pay labor and capital opportunity costs

If TR < VC or if P < AVC

Firm should shut down immediately

If price is above AVC but below AC,

the firm should continue producing but exit ASAP to minimize losses

If price is at or above AC,

the firm should continue producing where P=MC or enter if not already in industry

increasing cost industry

An industry in which industry costs increase with greater output, shown w/ upward-sloped supply curve

constant cost industry

An industry in which industry costs don't change with greater output, shown with a flat supply curve

conditions for a competitive industry

1. Similar products across sellers

2. Many buyers and sellers, each small relative to total market

3. Many potential buyers and sellers

decreasing cost industries

An industry in which industry costs decrease with greater output (supply curve slopes down). Costs are TEMPORARY reductions (ex. Silicon Valley CA). Once cluster is established, industry will turn to constant or increasing costs.

elimination principle

Above normal profits cause entry, below normal profits cause exit until rates of return are equal. Above normal profits are TEMPORARY! Entrepreneurs must innovate to obtain above normal profits

monopoly

The power to raise prices ABOVE marginal cost without the fear of competition

monopolies can be caused by

Patents

Laws preventing entry of competitors

Economies of scale

Hard-to-duplicate inputs

Innovation

Copyright

Network effects

The more ______________ the demand curve, the more a monopolist will raise price above MC

inelastic

rent seeking

activities undertaken by individuals or firms to influence public policy in a way that will increase their incomes.

first degree or perfect price discrimination

consumers are charged the maximum price they are willing to pay

second degree price discrimination

A price structure in which the seller charges a uniform price per unit for one specific quantity, a lower price for an additional quantity, and so on.

third degree price discrimination

practice of dividing consumers into two or more groups with separate demand curves and charging different prices to each group

arbitrage

Taking advantage of price differences for the same good in a different market by buying low in one market and selling high in another

formula for profit

Profit = Total Revenue - Total Cost

Formula for total revenue

Total Revenue = Price * Quantity

formula for total costs

Total Costs = Fixed Costs + Variable Costs

formula for average costs

Average Cost = Total Cost / Quantity

Oligopoly

an industry dominated by a small number of firms

cartel

small number of firms that cooperate to raise prices. tend to be unstable due to cheating by cartel members, new entrants, and U.S. govt. prosecution and regulation

the incentive to cheat

Cheating can result in more revenues for the cheater. Each firm can gain market share and not affect the price too much by slightly lowering their price

game theory

Evaluates alternate strategies when outcome depends not only on each individual's strategy but also that of others.

how can firms escape the prisoner's dilemma

small numbers of homogenous players can cooperate more easily

tacit collusion

collusion without explicit agreement or communication. harder to prosecute because its difficult to prove

Prisoner's Dilemma

a game in which pursuing dominant strategies results in noncooperation that leaves everyone worse off

bid rigging

firms agree to submit high bids, one submits low, and identity rotates

loyalty programs

customers are only better off not joining the loyalty program if most customers refuse. prisoner's dilemma.

vertical integration

control over various stages of production and distribution. no monopoly power

horizontal integration

control over various firms in the same stage of production. economies of scale and monopoly power.

mfg pool

purpose is to restrict output. if demand curve is inelastic,TR goes up, or divide and apportion the existing output. based on voluntary compliance and little enforcement mechanisms, so there is cheating and entry

trusts

stockholders in 2+ firms deposit controlling portion of their stock (in return for a trust certificate) in the hands of a trust who then controls all the companies.

merger movement

Late 19th and early 20th century effort to integrate different enterprises into single, giant corporations able to eliminate competition, achieve economic order, and boost profits. since manufacturing is not commerce, trusts and mergers are legal. followed by E.C. Knight sugar trust decision in 1894

public interest

preventing monopolistic behavior anti trust increases social welfare

special interest

by regulating larger, more efficient firms, anti trust acts as a protection for small businesses harmed by creative destruction

clayton act of 1914

prohibited predatory price cutting and tie-in sales. called the laborer's magna carta, because it declared that unions are not conspiracies in restraint of trade