Econ test 2

Taxes

The government levies these on many goods and services to raise revenue to pay for defense, schools, etc; percent of price amount for each unit

Tax on buyers

Results in a downward shift in demand; increase in price, some by buyer, some by seller

Incidence of tax

Both buyers and sellers absorb the price of the tax, no matter who the tax was levied on

Tax on sellers

Results in a downward shift in supply; increase in production price (thus again results in an increase in price absorbed by the buyer and seller)

Elasticity and tax incidence

If supply is MORE elastic than demand, buyer absorbs more of the tax, but if supply is LESS elastic than demand, seller absorbs more of the tax

Consumer surplus

Area above the price but below the demand curve (its a triangle); a higher price reduces surplus, increases deadweight loss

Producer Surplus

Area below price but above supply curve; reduced by a price decrease

Total surplus

Consumer surplus + producer surplus; equilibrium is most efficient (price increases and decreases reduce surplus)

Determinants of deadweight loss

Elasticity determines the amount of deadweight loss from price increase or decrease; more inelastic=smaller deadweight loss

Method for most efficient taxation

Taxing the good with the smallest deadweight loss

Tax effect on deadweight loss

Deadweight loss increases exponentially with size of tax

Financial planning takeaways

• Have 10% of income readily available (cash)

• Always reinvest dividends and diversify

• S&P 500 always go

Externality

Uncompensated impact on third parties; best visualized by social cost (can be positive or negative)

Negative externalities

Ex. antibiotics; best way to counter is a tax equal to the social cost (distance between market equilibrium and social cost and makes up deadweight loss); market quantity larger than socially desirable

Positive externalities

Ex. flu shots; best way to counter is a subsidy equal to social benefit, reduces deadweight loss (distance between market equilibrium and social benefit); market quantity smaller than socially desirable

Private cost

The cost paid by the producer and consumer

Private value

The price that buyers are willing to pay

External cost

The value of the negative impact on bystanders (3rd party)

Social cost

Private + external cost

Internalizing the externality

Altering the incentives so that people take account of the external effects of their actions (ex. imposing a tax or subsidy)

External benefit

The value of the positive impact on bystanders

Command-and-control policies

Regulates behavior directly (ex pollution limits); rarely efficient

Market-based policies

Incentives so private companies choose good outcomes on their own (Ex. gas tax or pollution permit); allows flexibility and is usually more market efficient

Corrective tax

A tax designed to induce private decision makers to take account of the societal costs that arise from a negative externality; align private incentives with societies interest; moves economy and is more efficient (also caller Pigouvian tax); for positive externalities

Coarse theorem

If private parties can costlessly bargain over the allocation of resources, they can solve the externality problem on their own; only works if property rights are clearly defined and transaction costs are low

Types of private solutions to externalities

Charities, moral codes and social sanctions, and contracts between market participants and the affected bystanders

Why private solutions don’t always work

Transaction costs, stubbornness, and coordination problems

Excludability

A good that someone can be prevented from using

Rivalry

If one person using a good diminishes others’ use

Private goods

Rival and exclusive; bananas, housing etc.

Club goods

Exclusive, but not rival; satellite tv, wifi

Public goods

Not exclusive or rival; national defense, fireworks displays, mosquito control

Common resources

Not exclusive but rival; timber, fish stocks, clean freshwater (tragedy of the commons)

Forced riders

Must pay for goods even if they don’t want/agree with them; can only happen in public goods sector (ex. taxpayers)

Free riders

People who reap the benefit without paying for it; can only happen in public goods sector (ex watching a firework show)

Cost-benefit analysis

A study that compares the costs and benefits of providing a public good

Gross domestic product

The market value of all final goods and services produced within a country in a given time-usually a year or quarter

Final goods

Intended for the end user (factored into GDP)

Intermediate goods

Used as components or ingredients in the production of goods; not factored into GDP (ex eggs bought for bakery selling cakes)

Components of GDP

Consumption, Investment, Government purchases, and net exports

Consumption

Total spending by households on goods and services; biggest percentage component; includes rent and imputed rent for homeowners (not mortgage or repairs)

Investment

Total spending on goods that will be used in the future to produce more goods; capital equipment (machines and tools), Structures (factories and offices), and inventories (goods produced but not yet sold)

Government purchases

All spending by government on goods and services (federal state and local); excludes transfer payments like unemployment (intermediate good)

Net exports

Exports-imports, can be negative

Underground economy

Adds 7-12% to nations GDP if counted; part of the economy but not counted as GDP; is a larger chunk of GDP in more unstable economies (ex. drugs, cash payments, bartering)

Nominal GDP

Values output for current prices; does not account for inflation (not as accurate at measuring growth)

Real GDP

Values output using the prices of a base year, correcting for inflation (more accurate measure of GDP growth)

Real GDP per capita

the main indicator of an average person’s standard of living; not a perfect measure of well being

GDP does not value

The quality of the environment, leisure time, non-market activity (child care provided by parent at home), an equitable distribution of income

Welfare economics is the study of

How the allocation of resources affects economic wellbeing

Cost

The value of everything a seller must give up to produce a good