Unit 2 Economics

Consumer Surplus

the benefit consumers receive when they pay a price below what they were willi by to pay

Producer Surplus

the benefit of a producer when they sell for a price higher than what they were willing to sell for

Social Surplus

consumer surplus + producer surplus

State of Market at Social Surplus

MC equals MB

Wellfare

the general prosperity of a society

When is social wellfare maximized?

When social surplus is maximized

Demand Function

Qd = a - bP

Changes in “a” in the demand function cause__

shifts

Changes in “b” in the demand function change __

steepness

Supply Function

Qs = c + dP

Difference between market demand and individual demand

Market demand is made up of individual demands

Different between market supply and individual firm’s supply

An individual firm’s supply is based on yhe production of a single product while yhr market’s supply is determined by the supllies of many firms

Elasticity

A measure of the responsiveness or sensitivity of a variable to changes in price or any of the variable’s determinants

Who cares about elasticity?

Businesses and governments

Types of Elasticity

Price elasticity of demand, Income elasticity of demand, price elasticity of supply

Price Elasticity of Demand

measure of the responsiveness of the quantity of a good demanded to changes in price

PED Formula

change% of quantity demanded of good x/change% of price

At what values is the PED relatively inelastic

0 < PED < 1

At what values is the PED relatively elastic?

PED > 1

At what values is the PED perfectly inelastic?

PED = 0

At what values is the PED perfectly elastic?

PED = infinity

At what values is the PED unit elastic?

PED = 1

SPLAT

The Determinants of PED

Articles of SPLAT

the availability of substitutes, proportion of income, luxury or necessity, addiction, time it takes customers to respond to price changes

When does the proportion of income cause elasticity?

when the product is a high amount of your income

When does the luxury vs. necessity metric cause elasticity

When the product is luxury

When does addiction cause elasticity?

When people are not addicted

When does the availability of substitutes cause elasticity?

when there are many substitutes

When does the time to respond increase elasticity?

When customers respond to price changes quickly

Reasons firms care about PED

total revenue, price discrimination

Price Discrimination

when firms charge distinct groups of buyers different prices for the same products

Why do governments care about PED?

for taxes

Direct tax example

income tax

How does direct tax affect elasticity

the lower the elasticity of the demand for the good being taxes, the larger the tax revenues for the government

Examples of governments using elasticity to their advantage

taxing cigarettes

Income Elasticity of Demand (YED)

the measure of the responsiveness of demand to changes in income

Usefulness of YED

shows whether a good is normal or inferior and the magnitude of that status

Formula for YED

change% in quantity demanded of good x/change% of income

YED < 0

inferior good

0 < YED < 1

income inelastic, normal

YED > 1

income elastic, normal

How do firms use YED

reveals to firms which products are likely to have rapidly expanding markets

How does high YED show expansion potential

high YED high expansion

Merit Good

A good that is useful to society, but is scarce

Demerit good

a good that is bad for society, yet overconsumed

What happens to the prosperity of sectors as income increases?

Tertiary sector gets more business

Elasticity of Tertiary Sector

Income elastic

How do firms use YED

during a recession, businesses that make inferior goods thrive.

during booms, firms that produce normal goods thrive.

Recession

economic activity decreases for 6 months in a row

How do governments use YED?

a tax increase reduces demand for normal goods and increases demand for inferior goods

Price Elasticity of Supply

measure of the responsiveness of the quantity of a good supplied to changes in price

Determinants of PES

amount of time following a change in price, mobility of factors of production, storage, unused capacity, input availability

How does PES change after in the short run of time after a change in price

the PES is inelastic

How does PES change when FOP is mobile

more elasticity because suppliers can react faster

How does PES change when storing perishable goods

inelastic, because they don’t have many goods in reserve

How does PES change when there is little  unused capacity

in it inelastic because in order to react to larger evet, the size of capital assets would need to be increased

How does PES change when inputs are not available

causes inelasticity because suppliers can make a limited amount of products

Short-run

at least one factor of production is unchanging

Long-run

all factors of production have changed

Applications of PES for firms

line managers use pes to see the effects of excise taxes

Indirect Tax Definition

an indirect tax levied by governments on the manufacture, sale, or consumption of specific goods, services, or activities.

Applications of PES in the government

uses PES to determine which price controls they should enact in the market

Econ

The economic assumption that human behaviour is perfectly rational

Rational behaviour

behaviour that aims to maximize utility or profit. also behaviour based on preferences that remain stable overtime

Characteristics of Rational Consumers

preferences for stable products, transitive preferences, strong analytical skills, perfect information, maximizing utility at all times

The Dual Process Model

a theory that humans have two broad ways of thinking

System 1

automatic, shallow, and effortless thought. used at most times

System 2

concious and deliberate thinking. isn’t always active

Bounded Rationality

humans are irrational in predictable ways

System 2

Satisfice

making satisfying choices that don’t maximize utility

Imperfect Information

the parties in a transaction have different/limited info

Bounded Self-Control

having limited self control

Bounded Selfishness

people can be both selfish and cooperative

Choice Architecture

the way choices are structured for customers

Default Choice

an option is chosen for customers, but they can change it

Restricted Choice

choices are limited or in small number

Mandated Choicr

forcing a customer to make a choice at a specific moment so that they think and don’t procrastinate

Tariff

Tax on imported goods

How do governments intervene in the market?

subsidies, indirect taxes, price controls

Specific Tax

a set amount charged to the product’s cost

Ad Valorem Tax

a percentage tax

Effects of Taxes

higher prices, less output, customers and producers are worse off, government benefits

Tax Incidence

the measure of the consequences of a tax on all affected parties

PED Burdens

elastic - producer

inelastic - consumer

How to change/reduce burdens

change elasticity

PES Burdens

elastic - consumer

inelastic - producer

Why do governments impose indirect taxes?

source of revenue, discourages consumption of demerit goods, can redistribute income, improves allocation of resources by reducing negative externalities

subsidies

assistance from the government to individuals or groups of individuals, such as firms, consumers, industries, and economic sectors

Goal of Subsidies

lowers a firm’s expenses, lowers price paid by customers, increases production

Why do governments give subsidies to firms?

they can increase production revenue, makes some goods affordable to low-income consumers, encourages production and consumption of merit goods, supports some industries’ growths, improves resource allocation by correcting positive externalities

Effects of a subsidy

low consumer prices, producers get more revenue, government expenditure increases which hurts the national budget, workers find new jobs as a result of the subsidy, society is worse off due to overallocation

Nudge

A subtle intervention that influences behavior without restricting choices or providing financial incentives.