econ unit 9 ppt

• Positive Economics:

  • Describes and measures how the world is.

  • Objective, ___-based (“what is”).

  • “Taxes reduce the quantity sold.”

• Normative Economics:

  • Prescribes what __ be done (policy recommendations).

  • Value-based (“what ought to be”).

  • “Taxes on cigarettes should be higher to discourage smoking.”

fact, should

2. Preferences, Choices, and Welfare

• Example: Is smoking bad for you?

  • Health effects: Negative.

  • Individual decision: Some people still choose to smoke because benefits (pleasure) outweigh costs (health risk) for them.

• Economic well-being is based on ___ preferences.

Economists assume ___ can be inferred from choices (revealed preference theory).

individual, preference

Welfare and Distribution – The Pie Analogy

• Society’s resources = a “pie.”

• Welfare economics studies how to divide the pie fairly and efficiently.

• Fairness → Who should get what?

Efficiency → How to maximize total __ of the pie?

value

Who Should Get a Concert Ticket?

Two people: S (Sarah) and K (Kevin)

• Both want the ticket, but value it differently.

• Kevin offers $100, Sarah offers $500.

• Sarah values it more → most efficient if she gets it.

Efficiency principle: Goods should go to those with highest __

willingness to pay

Fairness vs. Efficiency

• Fairness: Everyone treated equally or deserving parties rewarded.

• Efficiency: Maximize total ___ or total ___.

• These two goals often conflict.

• Should the most enthusiastic person always win, or should we share fairly?

benefit, surplus

Pareto Improvement: A change that makes at least one person better off __ making anyone worse off.

without

• Pareto Efficient Outcome:

  • No further Pareto improvements are possible.

  • All mutually beneficial __have occurred.

trades 

✅ Implications:

• A ___ efficient allocation = resources fully optimized.

• Most non-controversial measure of welfare.

Requires minimal information (who is better off or worse off).

pareto

• Many outcomes are not __(some people gain, others lose).

• Money transfers can make comparisons possible.

comparable 

7. Visual Example of Pareto Improvements

• If Sarah and Kevin both end up happier → ___improvement.

• If one gains and the other loses → __ a Pareto improvement.

• Transferring $200 from Sarah to Kevin can make both happy if she values fairness.

pareto, not 

Value ≠ Price — WTP measures how much someone __ pay, not what they do pay.

would

Demand curve ≈ _

marginal willingness to pay

Area under demand curve = total __/benefit from consumption.

value

Consumer Surplus (CS) - The excess benefit a consumer receives from a good over the price paid.

CS =__ - ___

WTP - P 

• Area under demand curve above ___line = consumer surplus.

• Represents monetary value of consumer happiness.

price 

Producer Surplus (PS) - The excess revenue producers receive over their production cost.

PS = ___ – __

price - marginal cost

Graphically: Area above ___ curve and below price line = producer surplus.

MC

Total Surplus = Consumer Surplus + Producer Surplus

• Measures overall __ or total “pie” society gains from trade.

• Does not depend on ___ distribution between buyers and sellers.

Only depends on __ traded.

welfare, price, quantity

Total Surplus and Price

• Changing ___redistributes the surplus (changes who gets what).

• But ____stays constant if quantity traded is unchanged.

Only the volume of ___ (Q) affects total surplus size.

price, total surplus, trade 

Is Money a Good Measure of Happiness?

• Economists often use __to measure welfare, but it’s imperfect.

• Problems:

  • Ability vs. willingness to pay differs.

  • Fairness & dignity not captured by money.

  • Transfers may improve fairness without changing efficiency.

Lionel Robbins (1945): Comparing satisfaction across people involves __judgments

money, value 

14. Maximum Market Surplus

• Total (market) surplus is maximized at equilibrium: Where Demand (___) = MC

• At this point:

  • No underproduction or overproduction.

  • All mutually beneficial trades happen.

MB

Deadweight Loss (DWL) - The loss of total surplus due to inefficient level of trade (less than or more than equilibrium).

• Underproduction: Some beneficial trades never occur.

• Overproduction: Some costly, ___trades occur.

DWL measures market __.

unprofitable, inefficiency 

Underproduction	Too little traded	Missed beneficial trades → DWL
Overproduction	Too much traded	Cost __ benefit → DWL
Equilibrium (MC = MB)	Efficient trade	No DWL

> 

• Competition → reduces ____surplus but increases____

• Monopoly power → higher prices, lower quantity → creates DWL.

Perfect competition → maximizes total ___.

producer, total surplus, welfare 

Price Discrimination - Selling the same product at different prices to different buyers.

• Effects:

  • Reduces___

  • May increase total surplus (by serving more customers).

• Perfect price discrimination:

  • Each buyer pays exactly their ___

Total surplus maximized, consumer surplus = __

consumer surplus, WTP, 0

Sources of Market Inefficiency

1. Market Power: Monopolies, collusion, __ to entry.

2. Externalities: Pollution, public goods, congestion.

3. Market Frictions: Search costs, imperfect information, contract issues.

Behavioral & Moral Factors: Bounded rationality, fairness preferences.

barriers

Taxes: Decrease total trade → can reduce __

total surplus

Subsidies: Increase total trade → can ___ total surplus depending on case.

raise or lower

Goal of gov intervention tax and subsidies : Correct market failures (__, fairness).

externalties

• People care about fairness, not just efficiency.

• But they disagree on what “fair” means.

Economic policy involves balancing __ (size of pie) and fairness (division of pie).

efficiency

Jeremy Bentham / John Stuart Mill (Utilitarianism)

Maximize total ___(sum of utilities).

happiness 

John Rawls

Focus on improving the well-being of the __

poorest

Robert Nozick

Fairness = respecting individual __ and voluntary exchange.

rights

Amartya Sen

Focus on __—what people are actually able to do or be.

capabilities 

Pareto Efficiency

No one can be made better off __ hurting someone else

Benchmark of efficiency

without