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Practice Micro Test 2

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Hannah Holmes

Practice Micro Test 2 03/06/2013 11:26:00 PM Chapter 6 and 8 A price ceiling: is a legal maximum on the price at which a good can be sold The price ceiling is not binding (not effective) if it is set above equilibrium price. The price ceiling is binding (effective) if set below equilibrium price, leading to a shortage Ex: maximum rent What if the province imposes a rent ceiling of $500?  Shortage = Qd-Qs  Sub in $500 for price A price floor: a legal minimum on a price at which a good can be sold The price floor is not binding if set below the equilibrium price. The price floor is binding if set above the equilibrium price, leading to a surplus. Ex: minmum wage W= wage dollars Labour measured in thousands of hours Puts minimum wage of 10 bucks  Surplus of labour: Qs-Qd o Unemployment A quota: a quantity control An upper limit on the quantity of a good that can be sold Government usually issues quota licenses that give producers a right to produce a specified amount of a good For example: The number of taxis in a city is strictly controlled The amount of fish you are allowed to catch and sell Often seen with dairy products and agricultural products Governments levy taxes to raise revenue for public projects. Tax incidence: The distribution of a tax burden  Taxes on beer  Notice that the burden of the tax doesn’t fall equally on consumers and sellers.  Before the tax, the consumers paid $3.00 and sellers received $3.00 per bottle.  After the tax,  Consumers pay $ .30 more per bottle.  Sellers receive $ .20 less per bottle. o In this case, the consumers bear the larger burden of the tax: $.30 versus $.20. Tax on suppliers Now, suppose instead that the government levies the tax on bar owners. Sellers react by supplying less beer at every price. The supply curve will shift up by the amount of the tax.  The burden of the tax is the same.  Consumers pay $ .30 more than before.  Sellers receive $ .20 less than before.  The consumer bears the larger burden of the tax. Taxes on consumers and taxes on suppliers are equivalent = end results doesn’t matter on whom the tax is levied Taxes reduce the quantity traded, increase the price that consumers pay and lower the price that suppliers recieve In our example, the consumers bore the larger burden of the tax. That’s because the demand curve is actually steeper than the supply curve. This turns out to be a general rule: The side of the market which is more inelastic (steeper curve) bears a larger burden of the tax.  Why inelastic?  Inelastic means less responsive to change  Can’t adjust in the short run to compensate to any great extent  If you can’t adjust, you are stuck with the heavier burden of tax What determines the size of the deadweight loss from a tax? Depends on the price elasticities of demand and supply; how responsive is demand and supply? The following examples show what happens to deadweight loss when the size of the tax remains the same and the demand curve is the same but supply elasticity changes. supply curve is the same but demand elasticity changes. DWL increases as supply becomes more elastic As demand become more elastic the DWL increased The greater the elasticities of demand and supply: The larger the decrease in equilibrium quantity due to tax The greater the DWL of a tax Increasing tax = increase in DWL But tax revenue is decreasing because less trading is happening For the small tax, tax revenue is small. As the size of the tax rises, tax revenue grows. But as the size of the tax continues to rise, tax revenue falls because the higher tax reduces the size of the market. Subsidies: payments given to producers in order to increase market output and / or decrease prices paid by consumers Think of them as opposite of taxes levied on producers They shift the supply curve out (to the right), resulting in a new equilibrium with more output and a lower equilibrium price DWL – money spent the government that does not benefit anyone in the marketplace Chapter 7 Welfare economics: The study of how the allocation of resources affects economic wellbeing Buyers and sellers in the market receive benefits from participating in the market Equilibrium in the market results in maximum benefits and therefore, maximum total welfare Consumer surplus  Every buyer in an economy is only willing to pay up to a certain amount for a good or service. We define:  Willingness-to-pay: the maximum amount that you are willing to pay for a certain quantity of a good  Also called a reservation price  How much value you place in the good Consumer surplus: the buyer’s willingness-to-pay minus the amount the buyer actually pays  The market demand curve depicts the various quantities that buyers would be willing and able to purchase at different prices  It depicts consumers’ willingness-to-pay; how consumers value the good Producer surplus: amount a seller is actually paid for a good (receives for a good) minus the seller’s willingness-to-sell (lowest price a seller will take to produce and sell a good); their cost  Willingness-to-sell: lowest price a seller will take to produce and sell a good Consumer Surplus = Value to buyers (D) – Amount buyer pays (pe) and Producer Surplus = Amount sellers receive (pe) – Cost to sellers (s) Since amount buyer pays = amount sellers receive Total Surplus = Consumer Surplus + Producer Surplus or Total Surplus = Value to buyers – Cost to sellers Free markets do 3 things: Allocate the supply of goods to the buyers who value them the most (they have the highest willingness-to-pay) Allocate the demand for goods to the least cost suppliers Produce the quantity of goods that maximizes total surplus = CS+PS Chapter 10 Sometimes there are benefits and costs that arise in the market that go uncompensated. These are called externalities. A positive externality: a benefit enjoyed by society but society doesn’t pay to receive it (ie. I enjoy the shade from my neighbour’s tree but it does not cost me a thing.) A negative externality: is a cost suffered by society and the instigator whose imposing this cost isn’t made to pay for the damage done (ie. The neighbour’s dog barks all night and keeps me up, but my neighbor does not compensate me). Negative externalities lead markets to produce more than is socially desirable. Positive externalities lead markets to produce less than is socially desirable. The government can internalize an externality: Impose a tax on producer to get them to produce less; to produce the socially desirable quantity Pigovian Tax A tax levied on each unity of output sold The social value: not alone the private value but it also includes the value to the rest of society The government can internalize the externality by subsidizing the production of the good – get firms to supply more. A property right: the exclusive authority to determine how a resource is used, whether the resource is owned by the government or individuals; need property rights in order to buy and sell Private property rights have two other attributes in addition to determining the use of a resource: Transaction costs: costs of bargaining These can be so high that private agreements are not possible Chapter 13 Profit = Total revenue – Total cost P = TR - TC Explicit and Implicit Costs A firm’s cost of production include explicit costs and implicit costs. Explicit costs: that require a direct outlay of money (you have a receipt for your accountant Implicit costs: don’t require a direct outlay of money (like the money you could have earned investing instead of updating your factories); no receipt for what you COULD have made Economists measure a firm’s economic profit as total revenue minus total cost, including both explicit and implicit costs, i.e., total opportunity costs. Accountants measure the accounting profit as the firm’s total revenue minus only the firm’s explicit costs. When total revenue exceeds both explicit and implicit costs, the firm earns economic profit. Economic profit is smaller than accounting profit because it includes implicit costs. Production function: shows the relationship between quantity of input used to make a good and the quantity of output of that good Marginal product: The increase in output that arises from an additional unit of that input Ie. If L increases my inputs by one (one unit), how much will my total product (total output) increase? MP = change in total output = rQ change in # of inputs rL In other words, MP is the slope of the total product function. Diminishing Marginal Product Diminishing marginal product: the marginal product of an input declines as the quantity of the input increases when you have fixed inputs too Notice that TP is maximized when the slope of the TP function is zero. Since the slope of the TP function is MP, TP is maximized when MP = 0 Average Product, AP = ____Q_____ # of inputs AP intersects MP at max AP Whenever MP > AP, AP must be increas Whenever MP < AP, AP must be decrease When AP = MP, AP is at its maximum. TP is maximized when MP = 0 Costs of production may be divided into fixed costs and
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