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Micro Midterm 2.docx

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McMaster University
Hannah Holmes

Micro Midterm #2 Welfare Economics: study of how the allocation of resources affects economic well- being. Equilibrium in the market results in maximum benefits and therefore maximum total welfare’ Willingness to pay: the maximum amount you’re willing to pay for a certain quantity of a good (also called reservation price), how much value you place on the good Consumer Surplus: the buyers willingness to pay minus the amount the buyer actually pays, = how consumers value the good. = the area under the demand curve above the selling price Producer Surplus (cost): the amount that a seller is actually paid for a good – the seller’s willingness to sell. = the area below the selling price and above the supply curve Consumer surplus = value to the buyers – amount buyer pays Producer surplus = amount sellers receive – cost to sellers Total surplus = consumer surplus + producer surplus Total surplus = value to the buyers – cost to sellers Market Efficiency: if an allocation of resources maximizes total surplus, that allocation is efficient. If an allocation of resources leads to well-being that’s fairly distributed among society’s members, that’s equity Free Markets: 1. Allocate the supply of goods to the buyers who value them the most (highest willingness to pay 2. Allocate the demand for goods to the least cost of suppliers 3. Produce the quantity of goods that maximizes total surplus = CS + PS Total Surplus: consumer surplus + producer surplus, It is maximized at equilibrium Deadweight losses: a loss in total surplus, happens when the quantity traded is less than what would be traded when the market is in equilibrium Externalities: benefits and costs that arise in the market that go uncompensated. They are created when a market outcome affects individuals other then the buyers and sellers in the market Positive externality: a benefit enjoyed by society but society doesn’t pay to receive it E.g. The shade from a neighbours tree that you do not pay for. Leads market to produce less then is socially desirable Negative externality: a cost suffered by society and the instigator isn’t made to pay for the damage they do. E.g. Neighbours dog barks and keeps you up all night but the neighbor does not compensate you. Leads market to produce more then is socially desirable Social cost: includes the private costs of producers plus the cost to the public adversely affected by the negative externality Internalize: the government imposes a tax on producers to get firms to produce less, to produce the socially desirable quantity. The government can also internalize an externality by subsidizing the production of the good – get firms to supply more Social Value: includes not only the private value to those who actually take the drug but also includes the value to the rest of society (increase demand) The coase theorem: a proposition that if private parties can bargain without cost over the allocation of resources, they can solve the externalities problem on their own Property rights: exclusive authority to determine how a resource is used whenever government or other individuals own that resource 1. The exclusive right to the services of the resource 2. The right to determine the use e.g. the apt owner has rights to deter
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