Econ EXAM #2

CHAPTER 6

what are the two types of price controls?

price ceiling and price floor

price ceiling:

legal MAXIMUM price

“you cannot charge more than this”

price floor:

Legal MINIMUM price

“you cannot charge less than this”

PRICE CEILING ABOVE EQUILIBRIUM PRICE

equilibrium: 6$</p><p>price ceiling: 5$

binding

PRICE CEILING BELOW EQUILIBRIUM PRICE:

equilibrium: 4$</p><p>price ceiling: 5$

non-binding

PRICE FLOOR ABOVE EQUILIBRIUM PRICE:

equilibrium: 3$</p><p>price floor: 2$

non-binding

PRICE FLOOR BELOW EQUILIBRIUM PRICE:

equilibrium: 2$</p><p>price floor: 3$

binding

price ceiling causes a _____

price floor causes a _____

-shortage (ex: rent control)

-surplus (ex: unemployment)

what tends to be more elastic?

long run vs short run

The long run tends to be more elastic because people have more time to respond

what is an example of a price floor in the labor market?

minimum wage

housing subsidies:

government helps poor families pay rent

what is a tax?

a payment to the government

what is a tax incidence?

The study of how the burden of a tax is distributed among buyers and sellers

SELLERS affected:

shift SUPPLY

BUYERS affected:

shift DEMAND

TAXES ON SELLERS

The government charges sellers $0.50 per ice cream cone.

1. which curve is affected?

2. which direction is it going?

3. what happens to the equilibrium?

1. supply

2. LEFT/upward

3. higher price paid by buyers, lower price recieved by sellers, lower quanity sold

TAXES ON BUYERS

The government charges buyers $0.50 per ice cream cone.

1. which curve is affected?

2. which direction is it going?

3. what happens to the equilibrium?

1. demand

2. LEFT/downward

3. quanity falls, buyers pay more, sellers recieve less

payroll taxes:

a tax on wages paid to workers

what determines who bears more of the burden?

elasticity

which side of the market bears more of the tax burden?

-inelastic

LESS elastic = pays more

elastic demand:

buyers can easily change what they buy or leave the market.

inelastic demand:

buyers have a harder time changing what they buy = less elastic

ELASTIC demand + INELASTIC supply

suppose:

demand(buyers) = elastic

supply(sellers) = inelastic

who bears most of the tax?

SELLERS bear most of the tax

Consumers can easily change their behavior.

But sellers can't easily leave the market.

INELASTIC demand + ELASTIC supply

suppose:

demand(buyers) = inelastic

supply(sellers) = elastic

who bears most of the tax?

BUYERS bear most of the tax

Buyers don't have many alternatives.

Sellers can easily leave the market.

What is the idea of the luxury tax?

Rich people buy luxury goods, so tax them.

DEMAND for yachts is highly elastic

SUPPLY of yachts is relatively inelastic

-sellers bear most of the tax

That means the tax could hurt yacht producers and workers rather than primarily hurting wealthy buyers.

Graph #1: Binding Price Ceiling

Equilibrium:

P = equilibrium

Government puts ceiling:

below equilibrium

Result:

Qd > Qs

SHORTAGE

Graph #2: Binding Price Floor

Equilibrium:

P = equilibrium

Government puts floor:

above equilibrium

Result:

Qs > Qd

SURPLUS

The equilibrium price of a good is $8. The government sets a price ceiling of $6.

Is it binding?

What happens?

yes, a shortage happens

The equilibrium price is $20. The government sets a price floor of $15.

Is it binding?

What happens?

no, no effect because it is not binding

A binding price ceiling creates a shortage because:

Qd > Qs

the government is forcing the price lower than it is so people want it more

ALWAYS REMEMBER:

Qd > Qs =

shortage

ALWAYS REMEMBER:

Qd < Qs =

surplus

Rent control is an example of a:

price ceiling

tax on sellers:

SUPPLY shifts left/up

tax on buyers:

DEMAND shifts left/down

CHAPTER 7

What is welfare economics?

The study of how the allocation of resources affects economic well-being

consumer surplus =

benefit to buyers

producer surplus =

benefit to sellers

CONSUMER surplus:

willingness to pay - actual price paid

-measures the benefit that BUYERS receive from participating in a market

Suppose you are willing to pay $100 for a concert ticket.

You actually pay $70.

you are willing to pay more than you actually had too so what is the consumer surplus?

30$

what curve represents buyers willingness to pay?

demand curve

-Area below the demand curve and above the price = Consumer surplus

marginal BUYER:

the buyer who would leave the market first if the price increased

Suppose:

• Whitney values the product at $1,000

• Ella = $800

• Mariah = $700

• Karen = $500

If 3 albums are sold, who is the marginal buyer?

Mariah is the marginal buyer.

Why?

Because Mariah is the last buyer who is willing to purchase.

If the price rises above $700, Mariah leaves the market.

what happens when price falls?

consumer surplus INCREASES

PRODUCER surplus:

Producer surplus = Amount the seller is paid − Cost of production

-It measures how much sellers benefit from participating in the market

A painter's cost = $2,000.

They receive $2,400.

Producer surplus:

$400

Suppose:

Seller	Cost
Vincent	$3,600
Claude	$3,200
Pablo	$2,400
Andy	$2,000

If the price is $3,200:

Andy:

Pablo:

Total producer surplus:

Andy:

$3,200 − $2,000 = $1,200

Pablo:

$3,200 − $2,400 = $800

Total producer surplus:

$1,200 + $800 = $2,000

Which curve helps measure producer surplus?

supply curve

The supply curve represents sellers' costs.

Therefore, the gap between:

Price received

and

Cost of production is…

producer surplus

marginal SELLER:

The seller who would leave the market first if the price DECREASED

For example:

• Andy cost = $2,000

• Pablo = $2,400

• Claude = $3,200

• Vincent = $3,600

If 3 sellers are producing, who is the marginal seller?

Claude is the marginal seller.

Why?

Because if the price falls below $3,200, Claude exits.

The supply curve reflects the cost of the marginal seller.

A seller's cost is $80 and they receive $110.

What is producer surplus?

30$

what happens when the price rises?

producer surplus increases

TOTAL surplus:

Total surplus = Consumer surplus + Producer surplus

Total surplus measures the total economic benefit created by a market.

-when we combine the formulas, the money paid by buyers and received by sellers cancels out. This leaves:

Total surplus = Total value to buyers - total cost to sellers

Suppose:

Consumer surplus = $500

Producer surplus = $300

Then:

Total surplus =

Total surplus = $800

efficiency:

An allocation is efficient when it maximizes total surplus.

In other words:

Efficiency = making the economic pie as large as possible

An outcome can be efficient even if one group gets much more of the economic benefit than another.

Why?

Because:

Efficiency = maximize total surplus

while:

Equality = fairness/distribution of that surplus

They are different concepts.

the area above the price and below the demand is:

The consumer surplus

-consumers will always be ABOVE price

the area below the price and above supply is:

The producer surplus

-Producers will always be BELOW price

the demand curve represents:

value to the marginal buyer

the supply curve represents:

cost to the marginal seller

Quantity below equilibrium:

-producing not enough of a product that the buyers value higher than the original price

value to buyer > cost to seller

Increasing quantity increases total surplus

quanity above equilibrium:

-producing too much of a good that the buyer does not value enough

value to buyer < cost to seller

Decreasing quantity increases total surplus

The three insights about competitive markets:

insight #1 - Competitive markets allocate goods to the buyers who value them the most

goes to the person who values it the most

The three insights about competitive markets:

Insight #2 - Competitive markets allocate production to sellers who can produce at the lowest cost

goes to the person who can make the good at the lowest production cost

The three insights about competitive markets:

Insight #3 - competitive markets produce the quantity that maximizes consumer surplus + producer surplus

amount of goods that has you reaching total surplus

at a quantity below equilibrium, the marginal buyer’s WTP is…

greater than the marginal seller’s cost

laissez-faire

it means let people do as the will in a market

Adam Smith’s invisible hand:

Refers to how individual decisions can lead to an efficient market outcome even though individuals are pursuing their own interests.

A buyer isn't thinking:

"I need to maximize society's total surplus."

They're thinking:

"I want this product."

A seller isn't thinking:

"I need to maximize society's welfare."

They're thinking:

"I want to make money."

Market Failure

Inability of some unregulated markets to allocate resources efficiently

1. market power

2. externalities

market power

the ability of a buyer or a seller to influence market prices

externalities

occurs when buyers’ or sellers’ decisions affect people who are not directly participating in the transaction

the market decisions is based on:

-buyers value

-sellers cost

ticket scalping

reselling tickets at a higher price

consumer and producer surplus graph:

at a quantity below equilibrium:

value exceeds cost

a lower price generally ___ consumer surplus

increases

the “invisible hand” refers to:

prices coordinating individual decisions in markets

CHAPTER 8

a tax does what 2 major things?

-raises revenue for the government

-it changes people’s behaviors

deadweight loss (DWL):

Some mutually beneficial trades no longer happen

tax revenue:

tax per unit x quanity sold

Once a tax is imposed, why do consumer surplus and producer surplus fall?

a tax causes:

• CS ↓

• PS ↓

• Government revenue ↑

But the government revenue does NOT fully compensate for the lost CS and PS.

The result is:

Deadweight loss = Loss in total surplus caused by the tax

A tax causes buyers and sellers to lose 100$ of surplus, but the government receives $ 70, what is the DWL?

$ 30

ORIGINALLY WITHOUT A TAX:

Mike’s opportunity cost = 80$</p><p>Mei values a clean house at = 120$

They agree on a price of = 100$</p><p>so..</p><p>Mike’s producer surplus = 20$

Mei’s consumer surplus = 20$</p><p>total surplus = 40$

AFTER ADDING A TAX:

Suppose the government imposes a 50$ tax on cleaning services, but Mei will pay at most 120$

-Mike needs at least $ 80 after tax, making the price 130

What happens?

Therefore:

No mutually beneficial price exists.

The transaction doesn't happen.

what is the DWL triangle?

The deadweight loss is the triangle between supply and demand over the units that are no longer traded.

Think:

Tax → smaller market → missing trades → DWL triangle

the more elastic supply and demand are, the ____ the deadweight loss from a tax is

LARGER

Quantity falls a lot → DWL is large

inelastic supply and demand:

sellers and buyers dont respond much to change so SMALL DWL

elastic supply and demand:

sellers and buyers heavily respond to change so LARGE DWL

perfectly inelastic means…

Quantity supplied does not change when the price changes.

Graphically:

Supply is vertical.

DWL = 0

If supply is perfectly inelastic, a tax on the good will:

create no DWL

what happens when the tax gets bigger?

deadweight loss increases

DWL triangle area:

½ x base x height

-larger tax = larger DWL

tax x2 =

tax x3 =

tax x4 =

Tax ×2 → DWL ×4

Tax ×3 → DWL ×9

Tax ×4 → DWL ×16

what is the laffer curve?

the relationship between tax rate and tax revenue

As the size of a tax increases, which statement is correct?

DWL increases while tax revenue eventually decreases

-This is because as the tax increases, DWL increases, which makes people want to pay less, decreasing tax revenue.

Deadweight loss measures ?

While tax revenue measures ?

-lost total surplus caused by tax (as tax increases, DWL increases)

-money collected by the government (as tax increases, revenue initially rises then can fall)

where is the economy currently located on the Laffer curve?

If the existing tax rate is on the upward-sloping portion:

Tax cut → lower revenue.

If the existing tax rate is on the downward-sloping portion:

Tax cut → potentially higher revenue.

conceptually deadweight loss is =

total surplus before tax - total surplus after tax