Study Guides (248,410)
Canada (121,516)
Economics (386)
ECON 101 (101)

Econ 101 Midterm 2 Review.docx

16 Pages
Unlock Document

ECON 101
Wokia Kumase

Chapter 5: Efficiency and Equity Alternative Methods of Allocating Resources - Market Price: used to allocate resources that two kinds of people buy o Those who can afford it but choose not to buy o Those who cannot afford it and therefore cannot buy o Does not work well with essentials that cannot be afforded - Command: used to allocate resources by the order of someone in authority o Works well when it is easy to monitor and responsibilities are clear o Not good when the range of activities that is to be monitored are large o Used in North Korea for a negative impact to the community - Majority Rules: when a majority of the voters choose where to allocate resources o Works well when decisions being made affect large number of people and self-interest has to be suppressed to allocate resources most efficiently o Society uses this method to select government to make big choices - Contest: the resource is allocated to the winner of an event o Works well when the efforts of the players are hard to monitor and reward o Sporting events use this method to get standings in playoffs - First-Come: First-Serve: allocates resource to those who are first in line o Works well when a scarce resources can serve just one user at a time o Used in the highway or restaurants to serve the first user - Lottery: Allocate resource to lucky individual who picked a winning number o Works well when there is no effective way to distinguish among potential users of a scarce resource o Used in casinos, OLG lottery companies and airport landing spaces - Personal Characteristics: allocate resources based on personal characteristics  Where person with the “correct” characteristics get the resources o No ways that it can be done “well” o Used in marriage proposals and discrimination against certain races - Force: allocation of resources done by lack of free will o Positive force: provides the state with an effective method of transferring wealth from rich to the poor o Negative force: the taking of property of others without their consent that causes billions of dollars worldwide to be reallocated  Example: War between nations Consumer Surplus - The excess of benefit received from a good over the amount paid for it o Area under the demand curve but above the price paid Producer Surplus - The excess of amount received from sale of a good over the cost of producing it o Area above the supply curve but below the price sold Connection between Demand and Marginal Benefit - Price is what we pay while Value is what we get out of it - Value of one more unit of a good is marginal benefit - Willingness to pay determines demand o Demand curve is a marginal benefit curve - Market Demand curve is the horizontal sum of the individual demand curves and is formed by adding the quantities demanded by all the individuals at each price - Societies marginal benefit is the marginal social benefit and the market demand curve is also the marginal social benefit curve (MSB) Connection between Supply and Marginal Cost - Cost is what a firm gives up to produce a good - Price is what a firm receives when it sells a good - Marginal cost is the minimum price that a firm is willing to accept - Minimum supply-price determines supply. - Supply curve is a marginal cost curve - Market Supply Curve is the horizontal sum of the individual supply curves and is formed by adding the quantities supplied by all the producers at each price - Societies marginal cost is the marginal social cost and the market supply curve is also the marginal social cost curve (MSC) Conditions in which Market is Efficient and Inefficient - Allocative efficiency is obtained at equilibrium o When MSB = MSC (Demand curve = Supply Curve) When the efficient quantity is produced, total surplus is maximized Total surplus is the sum of the consumer surplus and producer surplus The Invisible Hand: competitive market sends resources to their highest valued use - Assumes that consumers and producers act in their own self-interest o Market transactions generate an efficient use of resources Market Failure: when markets do not achieve an efficient outcome - Occurs due to too little of an item produced or too much of an item o Too little = Underproduction o Too much = Overproduction  These create dead weight losses  Decrease in total surplus that results from an inefficient level of production Sources of Market Failure - Price and Quantity Regulations o Puts a cap on the maximum price they can sell it for o Lead to underproduction - Taxes o Increase the prices paid by buyers and lower prices received by the sellers o Lead to underproduction - Subsidies o Decrease the price paid by buyers and increase prices received by producers o Lead to overproduction - Externalities o A cost or benefit that affects others than the seller or the buyer o When external cost arises, leads to overproduction  Electric company pollutes without considering climate change o When external benefit arises, leads to underproduction  Fire alarm installed in condominium protects himself without considering that he protects everyone - Public Goods o Consumed simultaneously by everyone even if they don’t pay for it  National defense and oxygen that we breathe is an example  Leads to under produced national defense since everyone wants to freeload off of it - Common Resources o Owned by no one but is available for everyone to be used  Atlantic salmon is an example  Leads to over used resources since it’s in everyone’s self interest to fish Atlantic salmon but they ignore extinction - Monopoly o A firm that is a sole provider of a good leads to underproduction  Local water supply or television cable company is an example  Monopolies try to maximize profit and self interest  To accomplish this, they produce little and charge high - High Transaction Costs o The cost of the services that enable a market to bring buyers and sellers together o Leads to underproduction Alternatives to the Market - Often, majority rules might been used in order to improve allocation of resources o However, a majority can pursue self interest - Managers in firms might use command to avoid high transaction costs o they would receive every time they needed a job done - First come first serve might be used as well Fairness and how Market Results in Unfair Outcomes Two main points It’s not fair if the results aren’t fair - General idea is that it isn’t fair if the incomes of people are too different within a company - Believes everyone deserves an equal piece of the pie per person o Example: Bank president makes millions while teller makes less is not fair - Efficiency requires equality of incomes - Utilitarianism is a principle that states we should strive to achieve the greatest happiness for the greatest number  Jeremy Bentham, John Stuart Mill; were utilitarian’s - 1) Everyone has the same basic wants and the similar capacity to enjoy one’s life - 2) The greater the persons income, the less marginal benefit and lesser the persons income, greater the marginal benefit - Big problem with utilitarianism is that it ignores the cost of making income transfers o The big trade off is the cost of making income transfers which is a trade between efficiency and fairness  Income can be transferred from rich to poor by taxing the rich only  However, taxing peoples income makes them work less than they would originally  This shrinks the economic pie o Trade off is between the size of the economic pie and the degree of equality with which it is shared It’s not fair if the rules aren’t fair - Based on the symmetry principle which is the requirement that people in similar situations be treated similarly - “Behave towards other people the way you wish to be treated” o This principle translates to Equality of Opportunity - Fairness obeys two rules o The state must enforce laws to protect private property o Private property may be transferred from one person to another, only by voluntary exchange - Fairness and Efficiency states that if private property rights are enforced and voluntary exchanges take place, resources will be allocated efficiently if there are no sources of market failure o Prices and quality regulations o Taxes and Subsidies o Externalities o Public Goods and common resources o Monopolies o High transaction costs Chapter 6: Government Actions on Market How rent ceilings create shortages and inefficiency - Price Ceilings or Price Cap is a regulation that makes it illegal to price higher than it o Effects are crucial when the ceiling is put below the equilibrium price  Above has no effect  Below produces a powerful effect - Rent ceiling is a price ceiling on housing o Shortage in housing  A rent ceiling makes it so that the quantity demand exceeds the quantity supplied in housing  When there is a shortage, quantity supplied is the quantity available which must be allocated to frustrated buyers o Increase of search in houses (Search Activity)  Causes the opportunity cost to not only be equal to the price, but to the time spent looking for the good  Might make the total cost of the housing to be more than what it would have been without the rent ceiling o A black market  An illegal market in which the equilibrium price exceeds the rent ceil  The more enforced the rent ceiling, the higher the price above equilibrium price  The less enforced the rent ceiling, the closer to the price of the equilibrium price  Eventually end up paying more than the equilibrium price - Inefficiency in Rent Ceilings o Causes underproduction of housing o Creates a dead weight loss as the marginal social benefit exceeds the cost  Producer surplus and consumer surplus shrinks  Also a potential loss from search activity - Are rent ceilings fair? o Using lottery, first come first serve, and discrimination, it allocates resources to decrease the quantity of scare housing  None of which are deemed fair How minimum wage create unemployment and inefficiency - Price floor is a regulation that makes it illegal to trade at a lower price than specified o When applied to labour market, it is called a minimum wage  If set below equilibrium wage, no effect is produced  If set above equilibrium wage, powerful effect is produced  Leads to unemployment o Quantity of labour supplied exceeds demanded  Demand for labour determines the level of employment - Inefficiency of minimum wage o The supply of labour measures the marginal social cost of labour to workers  The leisure time that they could have had o The demand for labour measures the marginal social benefit from labour  The value of the goods produced o The potential loss from increased job search decreases both workers’ surplus and firms’ surplus.  The total loss is the sum of the red and gray areas Tax Incidence and Elasticity of Demand - Tax incidence is the division of the burden of tax between buyers and sellers - Perfect Inelastic Demand o Demand for this good has a vertical demand curve  When a tax is imposed, buyers pay the entire tax - Perfect Elastic Demand o Demand for this good has a horizontal demand curve  When a tax is imposed, sellers pay the entire tax Tax Incidence and Elasticity of Supply - Perfectly Inelastic Supply o Supply for this good has a vertical supply curve  When a tax is imposed, sellers pay the entire tax - Perfectly Elastic Suppy o Supply for this good has a horizontal supply curve  When a tax is imposed, buyers pay the entire tax Tax on Sellers - Is like an increase in cost, it decreases the supply - We add the tax to the minimum cost and move it upwards / leftwards Tax on Buyers - Lowers the amount they are willing to pay sellers o Decreases demand and shifts the demand curve leftward - We subtract the tax from the maximum price that buyers are willing to pay for each Taxes and Efficiency - Except in extreme cases of Perfectly inelastic demand or perfectly inelastic supply when the quantity remains the same, imposing a tax creates inefficiency Taxes and Fairness
More Less

Related notes for ECON 101

Log In


Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.