SL Economics - Unit 2

Competitive Market

Where buyers and sellers carry out an independent exchange where no one individual has market power

Good vs Service

Goods are tangible. Services are not tangible

Demand

Quantities consumer is willing/able to buy at different prices

Law of Demand

higher price = lower demand (etc)

Increase Demand Graph

Decrease Demand Graph

Aggregate vs Market

Aggregate = whole economy. Market = 1 industry

Non-Price Determinants of Demand

Income (normal goods↑↑/inferior goods↑↓), preferences and tastes↑↑, price of substitute goods↑↑, price of complementary goods↑↓, population↑↑

Increase Quantity Demand vs Increase Demand

Increase quantity demand is a movement along demand curve (has to do with price). Increase demand is a shift.

Supply

Quantity producer willing/able to supply at different prices

Law of Supply

Increase price = increase supply

Increase Supply Graph

Decrease Supply Graph

Non-Price Determinants of Supply

Prices of related goods (joint supply↑↑/competitive supply↑↓), government intervention (tax↑↓/subsidy↑↑), cost of resource prices ↑↓, changes in technology↑↑, price of complementary goods↑↑, producer price expectations↑↓, number of suppliers↑↑, unpredictable events↑↓

Market equilibrium

The intersection between demand and supply

Surplus

QD > QS. P > Pe. Price often drops with surplus

Shortage

QD < QS. P < Pe. Price often increase with shortage

Price Elasticity of Demand (PED)

Measures how much QD responds to change in price

Price Elastic (Demand)

Demand is highly responsive to change in price (PED > 1)

Price Inelastic (Demand)

Demand not very responsive to change in price (PED < 1)

PED Formula

| (Qf-Qi / Qi) / (Pf-Pi / Pi) | or | %ΔQD / %ΔP|

Price Elastic Demand Graph

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Price Inelastic Demand Graph

Unit Elastic Demand Graph

Perfectly Elastic Demand Graph

Perfectly Inelastic Demand Graph

Determinants of PED

Number of substitutes, closeness of substitutes, necessities vs luxuries, length of time, proportion of income spent

Calculate total revenue

TR = QS x QD

Income Elasticity of Demand (YED)

How much demand responds to change in income

YED Formula

(Df-Di / Di) / (Yf-Yi / Yi) or | %ΔQD / %ΔY|

YED > 0 (positivie)

Demand for normal good

YED < 0 (negative)

Demand for inferior good

0 < YED

Income elastic demand (necessities)

YED > 1

income inelastic demand (luxuries)

YED Shifts in Demand Graph

Engel Curve

As you get rich, changes in income don’t affect you as much. Graph looks like a spiral

Price Elasticity of Supply (PES)

How much quantity supplied responds to change in price

Price Elastic (Supply)

Supply is highly responsive to change in price (PES > 1)

Price Inelastic

Supply is not very responsive to change in price (PES < 1)

PES Formula

(Qf-Qi / Qi) / (Pf-Pi / Pi) or or %ΔQD / %ΔP

Price Inelastic Supply Graph

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Price Elastic Supply Graph

Unit Elastic Supply Graph

Perfectly Elastic Supply

Perfectly Inelastic

Determinants of PES

Length of time↑↑, mobility of factors of production ↑↑, spare capacity of firms↑↑, Access to inventory ↑↑, rate at which costs increase, ↑↓

Indirect Tax Graph

Government Legislation Graph

Same as indirect tax

Price Floor Graph

Price Ceiling Graph

Subsidies Graph

Negative Production Externality Graph

Indirect Tax Externality Graph

Carbon Tax Graph

Traceable Permits Graph

Common pool resource

Resources not owned by anyone. Rivalrous (If I take some, less for you) and non-excludable. Examples: air, river, forest

Tragedy of the commons

Herders share field for cattle. As herd grows, grass decreases. Eventually there is no more grass.

Marginal cost (MC)

Cost to producers of producing goods.

2 Types of marginal cost

Marginal private cost (MPC): cost to private firm/producers

Marginal social cost (MSC): cost to society

Marginal benefit (MB)

Benefit to consumers for consuming goods

2 Types of marginal benefit

Marginal private benefit (MPB): benefits go to private individuals

Marginal societal benefit (MSB): benefits for society

Social surplus

Sum of consumer and consumer surplus

Externality

When actions of consumers/producers causes positive/negative side effects to third parties

2 types of positive externalities

Positive production externality: external benefit created by producers (research, new tech)

Positive consumption externality: external benefits created by consumers (education)

2 types of negative externalities

Negative production externality: external costs created by producers (pollution)

Negative consumption externality: external costs created by consumers (smoking)

Carbon tax

Tax per unit of carbon emissions of fossil fuels

Tradable permits

Permits to pollute issued by gov. which can be bought and traded

Collective self-governance

Solution to common pool resources where consumers choose to use sustainably

Market failure

Overallocation/provision: QS > QD

Under-allocation/provision: QS > QD

Not always bad as it signals areas to be corrected

Policies to correct negative production externality

Indirect taxes, carbon taxes, tradable permits, gov. legislation/regulation, education and awareness creation, collective self-governance

Advantages of market-based policies

* Can internalize externalities where costs are covered by producers and consumers
* Taxation on emission = less pollution/cost

Disadvantages of market-based policies

• May be impractical (calculating amount of emission is hard)

• Technical limitations

Advantages of government legislation and regulations

• Easier to implement

• Can avoid technical difficulties

• Highly effective

Disadvantages of government legislation and regulations

• More costly as no gov. revenue

• Can still face technical difficulties

• Cost involving monitoring regulations

Advantages of self-governance

* Sustainability without private or government ownership

Disadvantages of self-governance

• Unlikely

• Much communication needed

Education and awareness creation advantages

* Part of “natural” free market system

Education and awareness creation disadvantages

• May not be effective

• Difficult to measure

Positive production externality and graph

• External benefits created by producers

• MSC < MPC

• MPC – MSC = external benefit

Direct government provision externality

• Positive production externality

• Direct government provision to producers to continue to continue to produce goods/services

• Can be capital or resources

Direct government provision externality graph?????

Subsides external benefit

• Positive production externality

• Subsidy to a firm per unit of the good provided = external benefit

Subsides external benefit graph??????

Positive consumption externality and graph

• External benefits created by consumers

• Often caused by consumption of merit goods

• MSB > MPB

• MSB –MPB = external benefit

Government legislation and regulation

• Positive consumption externality

• Regulations to promote greater consumption of goods with positive externalities

Education and awareness creation

* Influencing consumer taste and preference to directly influence consumption choices (increase the demand)

Indirect tax

Is imposed on one person or group (like manufacturers), then shifted to a different payer, usually the consumer. (Taxes are put on goods, not consumers)

4 types of indirect taxes

Excise taxes, Specific taxes, Ad Valorem taxes, General sales taxes

Excise taxes

Are imposed on a particular goods and services

Specific taxes

A fixed amount of tax per unit of goods/service sold

Ad Valorem taxes

A fixed % of the price of the good/service (price up → tax up)

Direct tax

(Paid to the government by taxpayers. Suppliers →gov) income tax, business tax, property tax

Effects of indirect taxes (increase the price)

reduces consumer spending on taxed goods (QD decreases), signal producers to produce less (QS decreases)

Effects of indirect taxes (changes allocative efficiency)

Economy with a high degree of allocative efficiency → allocative efficiency goes down, welfare loss goes up. Economy with a low degree of allocative efficiency → allocative efficiency goes up (potentially)

Reasons for imposing indirect taxes

Indirect taxes → source of gov revenue. Indirect taxes are a method to discourage consumption of demerit goods. Indirect taxes can be used to redistribute income (by taking luxury goods) Indirect taxes are a method to improve the allocation of resources

Price ceiling

A gov setting a legal maximum price for a good. These are usually set to make certain goods more affordable to people on low incomes. Price ceiling must be below equilibrium price. AFFORDABILITY IS IMPORTANT. Creates a shortage.

Possible consequences of price ceilings

Non-price rationing (distribution of goods determined not solely by price). Underground (parallel) markets (black market) (unrecorded transaction involving markup on goods with price ceiling). Under-allocation of resources (allocative inefficiency), creates shortage. Negative welfare impacts (due to disequilibrium, max social surplus not reached; there is welfare loss)

A legal minimum price; sellers can’t charge less than this price. Must be above market equilibrium price. It creates a surplus

price floor

Creates surplus (QD

Possible consequences of price floor

Subsidies

A payment made to the firm by the gov (opposite of tax), to lower production cost. Right supply shift.