Microeconomics Test 2

Total Surplus

The sum of the consumer and producer surplus

Consumer Surplus

The difference between what consumers are willing to pay and market price

Willingness to Pay for a Good

Maximum price that you would buy a good at

Consumer surplus rises…

with a fall in price

Producer Surplus

The difference between market price and the price firms are willing to supply the product

Producer surplus rises…

with an increase in price

Price Controls

Legal restrictions on market prices

Price Ceiling

Pushes prices down, fewer sellers want to sell

Price Ceiling Side Effects

Inefficiently low quantity, inefficient allocation to consumers, wasted resources, inefficiently low quality, and black markets

Inefficiently Low Quantity (Ceiling)

Quantity supplied decreases; when prices are held below market price, shortages are created

Inefficient Allocation to Consumers

Price controls distort signals that allocate goods to their highest value users

Wasted Resources (Ceiling)

Buyers now compete through bribes/favors instead of by raising prices

Inefficiently Low Quality (Ceiling)

When price is controlled, sellers with reduce either quality/service

At a controlled price, sellers have…

more customers than goods

Price Floor

Pushes prices up, fewer buyers want to buy

Nonbinding Floor

Price floor set below equilibrium, which has no effect

Binding/Effective Floor

Price floor that forces price above the equilibrium, which has an effect

Price Floor Side Effects

Inefficiently low quantity, inefficient allocation of sales to sellers, wasted resources, inefficiently high quality, illegal activity

Inefficiently Low Quantity (Floor)

Quantity demanded decreases (deadweight loss)

Inefficient Allocation to Sellers

Allow high-cost firms to operate and prevent low-cost firms from entering the market

Wasted Resources (Floor)

Encourage waste

Inefficiently High Quality (Floor)

Buyers get higher quality but prefer lower prices

Higher quality raises…

costs and reduces sellers’ profits

Price controls benefit those…

who’re more organized/vocal

Deadweight Loss

Loss in total surplus that occurs when price controls are enacted

Quota

Upper limit, set by the gov’t, on the quantity of a good

Demand Price

Price of a given quantity at which consumers will demand that quantity

Supply Price

Price of a given quantity at which producers will supply that quality

Quotas impose…

deadweight loss and give incentives for illegal activity

Curves are elastic when…

an increase in price reduces quantity demanded/supplied by a lot

Curves are inelastic when…

an increase in price reduces quantity demanded/supplied just a little

Price Elasticity

Change in Quantity Demanded or Supplied/Change in Price

If Price E is 0

Perfectly Inelastic

Perfectly Inelastic

Price increase leaves QD/QS unchanged, vertical line

If Price E is less than 1

Inelastic

Inelastic

Increase in price causes an equivalent (to price elasticity) decrease in QD/QS

If Price E is 1

Unit Elastic

Unit Elastic

Increase in price causes an equal proportional decrease in QD/QS

If Price E is greater than 1

Elastic

Elastic

Increase in price causes an equivalent (to price elasticity) decrease in QD/QS

If Price E is infinity

Perfectly Elastic

Perfectly Elastic

At a given price, consumers will buy any quantity/sellers will sell any quantity, horizontal line

At price above Perfect Elastic price

QD/QS is 0

At price below Perfect Elastic price

QD/QS is infinity

Point Elasticity

((New QD - Old QD)/Old QD)/((New P - Old P)/Old P)

Midpoint Elasticity

((New QD - Old QD)/Average QD)/((New P - Old P)/Average P)

Midpoint Averages

(Old + New)/2

Total Revenue

Price x Quantity Demanded/Supplied

When price increases…

quantity sold decreases

When demand is inelastic…

total revenue rises when price rises

When demand is elastic…

total revenue falls when price rises

When demand is unit elastic…

total revenue stays the same

Price Elasticity of Demand Factors

Availability of substitutes, if the good is a necessity/luxury, share of income spent, and length of time since price change

More/Less Substitutes =

Elastic/Inelastic Demand

For necessities…

QD/QS doesn’t change much when P changes

For luxuries…

QD/QS is sensitive to P changes

We’re more/less sensitive to P changes when…

the good feels expensive/cheap

Consumers can adjust their behavior over time…

by finding substitutes, meaning higher elasticity (lower with less time)

Cross-Price Equality

% change in QD or QS of A/% change in B

For substitutes, Cross-Price Equality is…

Positive

For complements, Cross-Price Equality is…

Negative

Income Elasticity

% change in QD or QS/% change in P

For normal goods, Income Elasticity is…

Positive

For income-elastic goods…

income elasticity is greater than 1

For income-inelastic goods…

income elasticity is positive, but less than 1

For inferior goods, Income Elasticity is…

negative

Price Elasticity of Supply Factors

Availability of inputs, time

If increased production is expensive…

the supply curve will be inelastic

Price elasticity of supply increases…

with time

Incidence

Measure of who really pays a tax

Tax Imposed on Producers

Supply curve shifts upwards by amount of tax, demand stays the same, quantity falls

Excise tax burden fall on consumers when…

the price elasticity of demand is low and the price elasticity of supply is high

Tax Imposed on Consumers

Demand curve shifts downwards by amount of tax, supply stays the same, quantity falls

Excise tax burden fall on producers when…

the price elasticity of demand is high and the price elasticity of supply is low

Deadweight loss is larger…

when demand/supply are elastic

If the goal in tax policy is efficiency…

policymakers should choose goods with the lowest price elasticities

Benefits Principle

Those who benefit from public spending should bear the burden of the tax that pays for that spending

Ability-to-Pay Principle

Those with greater ability to pay a tax should pay more tax

Progressive Tax

Tax that takes a large percentage of income from high-income earners rather than low-income earners

Regressive Tax

Tax that takes a large percentage of income from low-income earners rather than high-income earners

Tax Base

Measure that determines how much tax one pays

Tax Structure

Specifies how the tax depends on the tax base

Increasing tax rate generally won’t…

increase revenue collected, since it will reduce quantity

Administrative Costs

The resources used to collect a tax