ECN 1A UC Davis

Welfare economics studies

The allocation of resources and how it relates to economic well being

A buyer's willingness to pay is

The maximum amount that a buyer is willing to pay for a certain good.

Willingness to Pay (WTP) demand curves often take the shape of ________.

Staircases and it has a negative slope. (Will get smoother as n increases)

What is consumer surplus?

The buyer's willingness to pay minus the actual cost of a good.

Cost is a measure of

willingness to sell

How do supply curves look?

Generally like willingness to pay curves, with the stair-steps but with a positive slope. Will get smoother with larger n.

Producer surplus

The amount a seller receives for a good minus the sellers cost.

How do you determine area of consumer surplus?

It is the area under the line/curve from line to the price paid.

How do you determine area of producer surplus?

It is the area above the line/curve from the line to price paid.

Total surplus

Total gains in a market

TS = PS + CS

or

TS = (price paid) - (cost of good for sellers to make)

What does it mean when we call a market efficient?

If a market is efficient, it allocates goods well.

It maximizes total surplus.

What is a test of efficiency?

Raising or lowering the Q of a good will not increase total surplus.

Who came up with the concept of an 'invisible hand?'

Adam Smith

What are two basic effects of a tax?

Increases the price consumers pay and decreases the price producers receive.

Reduces the quantity bought and sold

How do you calculate the revenue from a tax?

You multiply the size of the tax by the Q sold.

How does elasticity of supply and demand effect the size of the Dead Weight Loss?

Inelastic of either means that it is more difficult for consumers or producers to leave the market so the DWL is small.

If the goods are relatively elastic then the DWL will be larger.

Increasing a tax causes the DWL to

Increase at a faster rate than the tax increase. (It is an exponential relationship)

What does the Laffer curve represent?

What does it tell us about taxes?

The relationship between the size of a tax and the revenue.

It tells us that there is a middle point where taxes have the most revenue but really high taxes and really low taxes don't have much revenue. So it is beneficial to raise low taxes and decrease high taxes.

What is an explicit cost?

Obvious costs like electricity to run a building or wages or bills. Require money to be outgoing.

What is an implicit cost?

Things that are not generally very obvious. i.e. the potential wages given up while going to school, or the rent one could be charging in one's business.

They are opportunity costs.

Accounting costs vs. economic costs

Accounting costs simply take into account explicit costs but economic costs take into account explicit and implicit costs. They calculate including opportunity costs.

What does a production function show?

the relationships between quantity of inputs and quantity of outputs for a specific good.

What is the idea of diminishing marginal product?

The marginal gain from an input declines as Q increases. (While other things are equal)

What is included in total cost?

Fixed cost and variable cost.

The MC curve crosses the ATC curve at the ATC curve's

Minimum

If MC < ATC then the ATC is

If MC > ATC then the ATC is

falling

rising

Economies of Scale happen when

The Q is lower

ATC Falls as Q rises

Diseconomies of scale happen when

Q is higher

ATC rises as Q rises

What are the characteristics of a perfectly competitive market?

1. Many buyers and sellers

2. Sellers produce largely the same good

3. Firms can freely enter and exit

What does firms freely entering and exiting a market allow for?

No profits or losses in the long run.

If there are many sellers in a market who produce largely the same good what does that mean for the sellers? Are they price takers or price setters?

Price setters

What is average revenue of a competitive firm?

P or TR(total revenue)/Q

Formula for marginal revenue of a competitive firm?

Delta TR / Delta Q

What is true about MR (marginal revenue) for firms in competitive markets?

MR will stay the same as output increases. MR = P = AR

What Q maximizes a firm's profit?

MC > MR _______ Q

MC < MR _________ Q

Decrease Q to raise profit

Increase Q to raise profit

When MR=MC

You have reached the profit maximizing Q for a competitive firm

Shutdown vs. Exit

A shutdown is short-run and fixed-costs must still be paid

An exit is long term, and no fixed or variable costs have to be paid.

What would cause a firm to shut down?

If revenue loss or the cost of shutting down (TR [total rev]) is less than the benefits of shutting down (which would be the variable costs VC)

TR

What are sunk costs?

Costs that have already been committed too and have to be paid no matter if the firm shuts down. Like fixed costs.

What would cause a firm to exit?

If the TR is less than the TC

or P

What is the difference between a competitive firms long run and short run supply curves?

A firms SR supply curve would be the portion above the AVC however their LR supply curve would be that above the LRATC (Long-run average total cost)

What is the long run equilibrium?

It means that in the long run in a competitive market, firms will have zero economic profit.

In the competitive equilibrium, P =

MC, the supply curve of these firms is basically the MC curve.

In the long run P =

The minimum ATC

What is the difference between a monopoly and a competitive firm?

A monopoly is a price setter not a price taker, they have market power.

What are the three main causes of monopolies?

1. A single firms owns a key resource

2. The government gives exclusive rights to produce a good (i.e. patents)

3. Natural monopolies

What are natural monopolies?

A single firm can produce the good at a lower cost than several smaller firms could.

What does a demand curve look like for a monopoly?

It is the only seller so it faces the same demand curve as the market.

The monopolists MR _____ P(TR/Q)

less than

What do monopolies result in?

Dead weight loss

One difference between a perfectly competitive firm and a monopoly is that the competitive firm produces where

MC equals P, while monopolists produce where price exceeds marginal cost.

Marginal cost is equal to average total cost when

average total cost is at its minimum

For a typical monopoly average total cost is ________ and marginal cost is _______

falling; below average total cost

What is the shape of the monopolists marginal revenue curve?

A downward sloping line that lies below the demand curve.

Firms in competitive markets that have zero economic profits have accounting profits

Of at least zero

When a local grocery store offers coupons, it is most likely trying to

price discriminate

What is an externality?

A consequence of economic activity experienced by an unrelated third-party.

Is there ever a scenario where adding tax improves a market's efficiency?

No, because it always shrinks the market beyond the level that maximizes total surplus.

The price elasticities of supply and demand effect

both the size of the deadweight loss from a tac and the tax incidence

In a market economy, how might government intervention effect things?

May improve outcomes in the presence of externalities.

Private solutions may not be possible due to the costs of negotiating and enforcing these solutions. Such costs are called

Transaction costs

The length of term for a short run

Is different for different types of firms.

If a competitive firm is currently producing where marginal rev exceeds marginal cost then

A one unit increase in output will increase the firms profit.

A natural monopoly occurs when,

there are economies of scale over the relevant range of output.

Selling a good at a price determined by the intersection of the demand curve and the marginal cost curve is consistent with

Socially optimal level of output

Market solution for profit-maximizing competitive firms.

Price discrimination requires firms to

separate customers according to their willingness to pay.