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ECON 1B03 Study Guide - Midterm Guide: Planned Economy, Pigovian Tax, Coase Theorem

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Hannah Holmes
Study Guide

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Market economy: allocates resources through the decentralized decisions of
firms and households
Command or centrally planned economy: all production and distribution
decisions are made by a central authority, like a government
Opportunity cost: what you have to give up to get something.
oExplicit and implicit costs
Market failure can be influenced by market power: the ability of a single person
or firm to unduly influence market prices
Positive statements: describe world as is (descriptive analysis)
Normative statements: describe how world should be (prescriptive analysis)
PPF = production possibilities frontier
Comparative advantage: can produce at lower opportunity cost than someone
Absolute advantage: can produce a good using fewer inputs (e.g. less time)
Productivity = quantity produced / number of inputs used
Elasticity of demand: % change in Qd / % change in price. Drop –ve sign
Midpoint formula: Ep = (Q2 – Q1) / ([Q2 + Q1] / 2) ÷ (P2 – P1) / ([P2 + P1] / 2)
oInelastic: E<1 (% change Q < % change P), Elastic: E>1
oPerfectly inelastic E=0, perfectly elastic E=infinity
oNecessities inelastic. Luxuries, close substitutes, long time horizon elastic
Downwards demand curve: top left elastic, midpoint unit elastic, bottom right
Total revenue = price x quantity
oTR will increase if P increases, if demand is inelastic.
oTR will decrease if P increases, if demand is elastic.
oTR max when price elasticity = 1
Income elasticity = % change in Qd / % change in income. Sign matters.
oEI > 0, then normal good. (increase Q if increase income).
oEI < 0, then inferior good.
oEI between 1 and -1, good is income inelastic
oEI >1 or EI < -1, good is income elastic
onecessities income inelastic, luxuries income elastic
Cross-price elasticity of demand, Eab = % change Qd of ‘a’ / % change P of ‘b’
oE>0, substitutes. E<0, complements
Elasticity of supply: always +ve.
oEs between 0 and 1, inelastic. Es>1 elastic. rest, same as Ed
Consumer surplus: buyer’s willingness to pay, minus amt actually pays for it
Producer surplus: amt seller is paid for good, minus cost
Allocation efficient if maximizes total surplus (consumer + producer)
Pigovian tax = tax levied to correct negative externality of market (usu. by gov)
Coase theorem: if private parties can bargain without cost over the allocation of
resources, they can solve the externalities problem on their own. Sometimes, the costs
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of bargaining (called transaction costs) can be so high that private agreements aren’t
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