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COMMERCE 1B03 Study Guide - Midterm Guide: Black Market


Department
Commerce
Course Code
COMMERCE 1B03
Professor
Rita Cossa
Study Guide
Midterm

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Econ Test #2 Review
Chapters 7, 6&8, 10, and 13
Chapter 7: Consumers, Producers, and the Efficiency of Markets
Welfare Economics = the study of how the allocation of resources affects Economic
well-being
-buyers and sellers receive benefits from participating in the market
-the equilibrium of supply and demand in a market, MAXIMIZES the total
benefits received by buyers and sellers
Willingness to pay= MAX amount you are willing to pay for a good (how much the
buyer values that good)
-Also called RESERVATION PRICE
Consumer Surplus= buyers willingness to pay MINUS the amount the buyer actually
pays -measures the benefit to BUYERS in a participating market
**CLOSELY RELATED TO DEMAND CURVE
-the market demand curve depicts the consumers willingness to pay (their
value) for various quantities of a good.
-If there is less supply available people will be willing to pay more because the product is
scarce
**the lower the price, the GREATER the consumer surplus (consumers already buying
the good at the higher price are better off b/c they now pay less AND new buyers enter
the market because they are now willing to buy the good at the lower price)
Producer Surplus = the amount that a seller is paid for a good MINUS the seller’s
“costs” of production
-the benefit to the sellers of participating in the market
-CLOSELY RELATED TO THE SUPPLY CURVE
Cost = the value of everything a seller must give up to produce a good
Willingness-to-sell = the lowest price a suppler will take to produce a good and offer it
for sale
-reflected on the SUPPLY curve
Market Efficiency
CS = area of ABC
=1/2(bh)

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Consumer surplus is defined as:
Total Surplus = Consumer Surplus + Producer Surplus OR
Total Surplus = Value to buyers – Cost to sellers
-If an allocation MAXIMIZES total surplus, it is EFFICIENT
-If an allocation of resources leads to well-being that is fairly distributed throughout
society, that is EQUITY
-CS equals the area ABOVE the equ and BELOW the demand curve
-PS equals the area BELOW the equ and ABOVE the supply curve
Free Market:
1)buyers who value the goods the most get to buy them
2)the lowest cost producers get to sell the goods (using resources wisely and keeping
costs down). Efficient firms get to sell the goods
3)the quantity of goods is such that total surplus is maximized
**total surplus is maximized at equilibrium
Deadweight Loss
DWL = a loss in total surplus happens when the quantity traded is less than what would
be traded when the market is in the competitive equil
-the area of the triangle is the DWL
Chapter 10

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Externality = when a person engages in an activity that influences the well-being of a
bystander and yet neither pays nor receives any compensation for that effect.
1) Externalities are created when a market outcome affects individuals other than
buyers and sellers in the market
2) Externalities cause welfare to depend on more than just demand and supply to
buyers and sellers
3) Externalities can lead to inefficient markets and unaccounted for in production
and consumption decisions
Supply = Private Costs (producers)
Demand = Private Value (buyers)
Negative Externality = Adverse. A COST suffered by society and the instigator isn’t
made to pay the damage that results.
-EX: A neighbour’s dog that keeps barking all night long which keeps you
awake.
-exhaust from automobiles
**lead markets to produce MORE than sociably desirable**
-cost to society is larger than private costs to producers (ex: pollution of steel)
Social Cost = includes private costs of the producers PLUS the cost to the public
adversely affected by pollution.
TS = VALUE – COST
P - S
-The socially OPTIMAL LEVEL of output is LESS than equilibrium, which means we
do NOT account for the costs of pollution and end up producing too much of the good.
-“BAD” pollution takes away from the benefits, which then takes away from the TOTAL
SUPLUS (TS) in the market for that good.
The LOSS of SURPLUS is a DEAD WEIGHT LOSS due to the externality
The government can INTERNALIZE an externality:
-Alter incentives so that people take account of the
external effects of their actions
-Impose a TAX on the PRODUCER to make them
produce LESS (to produce socially desirable level)
Pigovian Tax = levied on each unit of output sold
Positive Externality = Beneficial. A BENEFIT enjoyed by society but society does not
pay to receive it.
-EX: a tree in a neighbours back yard (you didn’t pay for it) but you enjoy the
shade from the tree.
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