Econ 2

consumer surplus

the difference between what you pay & what you're willing to pay (willingness to pay)

• lower price = bigger consumer surplus, higher price = smaller

• ex. will pay more for antidote if bitten by snake

producer surplus

the difference between what the producer is paid & cost of producing

• higher price = bigger producer surplus, lower price = smaller

total welfare gains

the sum of consumer and producer surpluses

deadweight loss

the benefits lost by consumers and/or producers when markets do not operate efficiently

• gets larger as we move further away from the efficient equilibrium output

welfare effects

the gains and losses associated with government intervention

How is tax revenue calculated?

multiplying the amount of the tax times the quantity of the good sold after the tax is imposed (T × Q2)

• taxes lead to deadweight loss

diminishing marginal utility

the more u have of a good, the less satisfaction you'll get from it

The more elastic the demand or the supply curve, the _____ the deadweight loss

larger

subsidy

lower price to incentivize people to buy more of it

• creates deadweight loss & produces too much

What happens when there's a price ceiling/floor?

Price ceiling -> shortage, consumers win & producers lose, less output = deadweight loss

Price floor -> surplus, producers win & consumers lose, more output = deadweight loss

externalities

side effects that stop the market system from producing the efficient level of output

positive externality

when benefits spill over to an outside party who is not involved in producing or consuming the good

• ex. education, vaccines

negative externality

when costs spill over to an outside party who is not involved in producing or consuming the good

• ex. pollution

negative externalities in production

firms do not bear the full cost of their actions, and will produce too much (supply side)

• can get rid of it with a tax to reduce production

positive externalities in consumption

the market produces too little of the good or service (demand side)

• because producers are unable to collect payments from all those who benefit from the good or service, the market has a tendency to underproduce

transferable pollution rights

rights given to a firm to discharge a specified amount of pollution

• creates incentive to lower pollution levels

corrective tax

forces a firm to internalize the externality

• good because they get rid of externality & move society closer to efficiency

• only tax that doesn't result in deadweight loss

coarse theorem

bargaining between individuals or groups related to property rights will lead to an optimal and efficient outcome, no matter what that outcome is

adverse selection / asymmetric info

exists when one party has more info than the other

private good

rival in consumption

• ex. cheeseburger

public good

nonrival in consumption, causes free rider problem

• ex. national defense

moral hazard

individuals who are insured have reduced incentives to take precautions

• can result in higher insurance rates

mandatory spending

gov spending that's committed for the long run

• ex. social security & medicare

discretionary spending

programs that can be altered on an annual basis when the gov proposes a new budget

• ex. defense spending

progressive tax

the more u make, the more u pay in taxes

• ability-to-pay principle - rich people should pay more than poor people

regressive tax

the less u make, the more u pay in taxes

• ex. payroll tax

excise tax

sales tax

flat/proportional tax

everyone is charged the same percentage of their income

benefits received principle

individuals receiving the benefits are the ones who pay for them

• ex. gas tax = the more miles one drives, the more gas used, the more tax collected

consumption tax

gov taxes the amount that is spent rather than what is earned

public choice theory

the application of economic principles to the political process

individual-consumption-payment link

when a shopper goes to the store to buy groceries the shopping cart is filled with many different goods the consumer presumably wants & is willing to pay for

• only the things they want

explicit costs

costs that require a monetary payment, ex. out of pocket expenses like wages

• accountants only look at this cost

implicit costs

not monetary, opportunity costs of alternatives that must be forgone

• economists look at explicit & implicit costs

sunk costs

costs that have already been incurred and can't be recovered

• as a result, they're irrelevant for any future action

What does a zero economic profit mean?

A zero economic profit is a normal profit because it means the firm is covering all explicit and implicit costs (total opportunity costs)

• accounting profits only look at explicit costs, so their profits will always be higher than economic profits

fixed costs

don't vary with the level of output, have to be paid even if no output is produced

• ex. property tax

What's the relationship between marginal product & marginal cost?

INVERSE relationship

• marginal product rises, marginal cost falls

• marginal product declines, marginal cost rises

total cost

total cost = fixed + variable costs, ATC = AFC + AVC

Where is optimal on the U-Shaped Average Total Cost Curve?

Optimal cost is in the middle, at the bottom of the U

short-run

capital is fixed, too brief for some inputs to be varied

long-run

all inputs are variable

• costs less in the long run since you have an optimal sized plant

Which is flatter, the long-run average total cost (LRATC) curve or the short-run average total cost (SRATC) curve?

The LRATC curve is much flatter than the SRATC curve. This is because firms can be more flexible in the long run.

economies of scale

when LRATC falls as output expands

• produce more & cost falls

diseconomies of scale

LRATC rises as output expands

• produce more & cost rises

constant returns to scale

LRATC does not vary with output

perfectly competitive market

there are many buyers and sellers

• because each firm is so small, its production decisions have no impact on the market

• price takers - must take the price given by the market because their influence on price is insignificant

What are some characteristics of perfectly competitive markets?

• Many buyers & sellers

• Identical (homogeneous) products

• Easy entry & exit

• Must take market price as given (price takers)

• Produces at the minimum point of the ATC curve in the long run and charges a price equal to that cost

• No profits in the long-run due to vultures

total revenue

the revenue that the firm receives from the sale of its products

• total revenue = price x quantity, TR = P x q

average revenue

total revenue divided by the number of units sold

• AR = TR / q

marginal revenue

the increase in total revenue resulting from a one-unit increase in sales

• MR = ΔTR / Δq

profit-maximizing level of output

a firm should always produce at the output where MR = MC, q*

What are the 3 steps for determining if a firm is making a profit?

P - ATC * number of units = profits

if P = ATC, there is 0 economic profit

A firm may continue to operate in the short run even if its average total cost—variable and fixed costs—is not completely covered. That is, the firm may continue to operate even though it is experiencing an economic loss. Why?

Because fixed costs continue whether the firm produces or not. It is better to earn enough to cover a portion of fixed costs than to earn nothing at all.

short-run supply curve

the portion of the MC curve above the AVC curve