Econ exam 2

Positive

Objective statements

Normative

Subjective statements; what should be

Iniquities of economic efficiency

1. Distribution matters, so it’s important to account for equity

2. Willingness to pay reflects ability to pay, not just MB (kim k buying stupid stuff because she can)

3. Means matter, not just ends (consequences and process of policies)

Consumer surplus

MB/D curve - price area; earned on all BUT last purchase

Producer surplus

Price - MC/S curve area; earned on all BUT last sale

Surplus-maximizing quantity

Has efficient allocation at equilibrium because greatest economic surplus

Deadweight loss

1. (left of SMQ) ES lost from underproduction; voluntary exchanges don’t occur

2. (right of SMQ) ES lost from overproduction; MC>MB to consumer; unit shouldn’t be made because they wont buy it

DWL = ES at efficient Q - actual ES (MB-MC)

Efficient allocation

Markets allocate goods to people with greatest marginal benefit; most willing to pay

Efficient production

Markets distribute production to lower costs

RR for markets

Produce until MB=MC → largest ES; surplus-maximizing Q

Self-interest and competition

Invisible hand makes overall efficient production/allocation

Comparative advantage

Who should make what/specialize in what; OC; explains where gains from trade come from; all about reallocating resources to better uses

Absolute advantage

Who’s best at making what; NOT if they SHOULD

Time Qs to find CA

OC of good 1 = 1 / 2 = answer (2’s units)

Number Qs to find CA

Mr. Gannett’s ratios

Prices

Signal wrapped in incentive; move markets to equib that maxes gains from trade

Market failure

When S and D don’t → efficient outcomes

Externalities

When choices made by buyers/sellers don’t reflect full set of C/B

Gov failure MF

Gov regulations → inefficiency → under/overproduction → DWL

Market power MF

Companies have pricing power and aren’t price takers; monopolies

Asymmetric info MF

Everyone SHOULD understand C/B for an efficient market

Irrationality

People systematically making errors → not following MB/MC

S and D curves represent

Well informed buyers/sellers interacting in a well-functioning market with perfect competition

Market failure examples

1. Market power undermines competitive pressures

2. Externalities → side effects

3. Info problems undermine trust

4. Irrationality → bad decisions

5. Gov can impede market forces

Marginal social cost/benefit

MSC/MSB = MPC/B + MEC/B

Change in price pertaining to externalities

NOT an externality because it’s a redistribution between buyers and sellers

Socially optimal quantity

Quantity most efficient for society (all costs, all benefits)

RR society

Produce more until MSB=MSC

Steps for socially optimal quantity

1. Predict equib Q to forecast future

2. Assess externalities

3. Find socially optimal Q that’s in society’s best favor

4. Compare forecast w/ SOQ

Coase Theorem

Private bargaining → socially efficient outcome if property rights are clearly assigned, transaction costs are low, and c’e full info

Private bargaining examples

• Side payments: I’ll pay you to stop/continue

• Strategic investments: google builds internet networks in Africa to increase google use

• Mergers: AT&T and google pair to benefit each other

Pigouvian tax

Corrective tax in amount of externality; lawsuits, norms, and social sanctions act the same way; MSC=MPC + tax

Pigouvian subsidy

Gov transfers $ or decreases cost for PE; in amount of external benefit; “good feeling” of doing a good thing acts like a subsidy; MSB=MPB + subs

Cap and trade

Programs by gov acting like a tax

• cap: quotas to regulate Q of NE

• trade: busn can trade # of permits for # of Q to reallocate resources efficiently

Nonrival

One person’s consumption doesn’t impact another’s

Nonexcludable

Not possible/extremely hard to exclude

Private goods

Rival, excludable; food, clothes, gas

Club goods

Nonrival, excludable; streaming video

Common pool resources

Rival, nonexcludable; fish in the ocean

Public goods

Nonrival, nonexcludable; national defense, clean air

Free rider problem

People have no incentive to pay for the good because paying doesn’t prevent consumption → gov often provides public goods and they’re underproduced

Public good rules

1. Just because gov provides it, doesn’t mean it’s PG

2. Just because it’s PG, doesn’t mean gov should fund

3. Just because gov should fund PG, doesn’t mean it should produce it

Business’s approach to PG

Try to turn PG into club goods; radios charge us via ads

Tragedy of the commons

People overconsume common resources; assign ownership rights

Solutions to externality problem

1. Private bargaining

2. Fix price (tax/subs)

3. Fix quantity (cap and trade)

4. Laws, rules, regulations

5. Gov provision of PG

6. Ownership to CR

Sum up private goods

Sum up Qs they want at each price; whether we sum vertically/horizontally depends on if it’s rival

Sum up public goods

Sum up willingness to pay (MB) at each quantity; whether we sum vertically/horizontally depends on if it’s rival

Rent seeking

Attempts by individuals and firms to use gov action to benefit themselves at expense of others; “rents”: profits in excess of competitive markets

Special interest legislation

Introduced by law makers at request of a group (corruption or campaign contributions); CONCENTRATED BENEFITS AND DIFFUSED COSTS!!!!

Knowledge problem

Info is decentralized; central planners don’t know what it takes to run a cafe like the workers do; fatal conceit of lawmakers and gov

Price floor

Minimum price; ex) minimum wage; even though producers are better off, consumers aren’t → lower ES; surplus of labor = unemployment

Effects of PF

1. Surpluses

2. Lost gains from trade

3. Wasteful increases in quality

4. Misallocation of resources

Price ceiling

Max price; ex) rent control, price control on prescription drugs; misallocation because consumers who buy product may not be the ones who value it most

Effects of PC

1. Shortages

2. Decreases in quality

3. Search costs

4. Misallocation of resources

Price controls and competition

DONT eliminate competition, only change it

Tax incidence

Whoever is more elastic pays less

Reasons we have taxes

1. Raising revenues to fund programs not provided by market

2. Transfer payments to redistribute income (SS and medicare)

3. Financing its own gov operations and salaries

4. Correcting market failure

Examples of taxes

• Individual income taxes

• Payroll taxes (funds transfer payments)

• Corporate income taxes

• Sales taxes

• Property taxes

Average tax rate

ATR = total amount of tax paid / income

Marginal tax rate

MTR = amount of tax paid on additional $ earned

First $50k c’e no TR; >$50k c’e TR=50%; ATR and MTR for $100k?

Pay $0 on first $50k; 50% on second $50k; pay $25k in the end → ATR = 25% MTR = 50%

Progressive tax

Increasing average rates as income increases; MTR and ATR increase w/ MTR > ATR

Regressive tax

Increasing average rates as income decreases

Proportional tax

Constant rates; ATR = MTR

MTR vs ATR’s influence

Economists believe MTR has a greater influence on behavior than ATR

Tariff

Tax on imported goods

Autarky

Analysis w/o international trade

Import is an input in production, what happens when c’e tariff?

Higher P of input → decreased production → decreased supply → increased P → decreased D → decreased hired workers → BAD BAD BAD

Steps to figure out tariff stuff

1. Find out new P

2. Determine QD and QS by domestic buyers/sellers at new P

3. Assess Q that will be traded (inc/decreased imports)

Red tape

Bureaucratic hurdles increase costs like tariffs, but don’t increase revenue

Import quotas

Limit Q of good imported, but don’t increase rev

Exchange rate manipulation

Change the price of your goods in foreign market; ex) China artificially depressing yuan so it takes more yuan to buy a dollar → US products are more expensive → less imports

If gov eliminates tariffs

Gains in CS > losses in PS